The determinants and dynamics of bid-ask spreads on the London stock exchange

Kojo Menyah, Krishna Paudyal

Research output: Contribution to journalArticlepeer-review

20 Citations (Scopus)


We analyze the effect of various factors on the size of spreads on the London Stock Exchange since “Big Bang” and find that the price of a security, volume of transactions, risk associated with security returns, and degree of competition among market makers explain 91 percent of the cross-sectional variation in spreads. The results are consistent with the argument that the inside spread encompasses the order-processing, inventory-adjustment, and adverse-information cost of spreads. We also investigate the speed at which spreads move toward their normal levels after a temporary deviation. Although the speed of adjustment varies across firms, the cross-sectional median of 0.896 indicates it takes more than one period (day) for the adjustment to be completed. The volume of transactions and the degree of competition among market makers are the significant factors that affect the speed of correction in spreads toward their normal levels. This implies private information is incorporated more quickly into prices for stocks with greater competition and high trading volume.

Original languageEnglish
Pages (from-to)377-394
Number of pages18
JournalJournal of Financial Research
Issue number3
Publication statusPublished - 1996


  • London Stock Exchange
  • trading

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