Bias in the Effective Bid-Ask Spread - Bjorn Hagstromer
Speaker : Bjorn Hagstromer
Buil. T - Room T104
The effective bid-ask spread measured relative to the spread midpoint overstates the true effective bid-ask spread in markets with discrete prices and elastic liquidity demand. The average bias is 18% for S&P 500 stocks in general, and up to 97% for low-priced stocks. Cross-sectional bias variation across stocks and trading venues can mislead stock selection and order routing decisions. The bias also undermines liquidity timing and trading performance evaluations, and can lead to that non-sophisticated investors overpay for liquidity. To overcome these problems, the paper proposes new estimators of the effective bid-ask spread.