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The difference between the ask and the bid quotes — the spread — has long been of interest to traders, reg-ulators, and researchers. While acknowledging that the bid-ask spread must cover the order processing costs incurred by the providers of market liquidity, researchers have focused on two additional costs of market making that must also […]
Huang And Stoll-The Components Of The Bid-Ask Spread - A General Approach
The difference between the ask and the bid quotes — the spread — has long been of interest to traders, reg-ulators, and researchers. While acknowledging that the bid-ask spread must cover the order processing costs incurred by the providers of market liquidity, researchers have focused on two additional costs of market making that must also be reflected in the spread.Amihud and Mendelson (1980), Demsetz (1968), Ho and Stoll (1981, 1983), and Stoll (1978) emphasize the inventory holding costs of liq-uidity suppliers. Copeland and Galai (1983), Easley and O’Hara (1987), and Glosten and Milgrom (1985) concentrate on the adverse selection costs faced by liquidity suppliers when some traders are informed.
