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

Kojo Menyah, Krishna Paudyal

Research output: Contribution to journalArticle

20 Citations (Scopus)

Abstract

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.

LanguageEnglish
Pages377-394
Number of pages18
JournalJournal of Financial Research
Volume19
Issue number3
DOIs
Publication statusPublished - 1996

Fingerprint

Bid/ask spread
London Stock Exchange
Factors
Degree of competition
Market makers
Information costs
Speed of adjustment
Order processing
Trading volume
Security returns
Private information
Median
Deviation

Keywords

  • London Stock Exchange
  • trading

Cite this

@article{e5ff98c490254069a883260cc5091521,
title = "The determinants and dynamics of bid-ask spreads on the London stock exchange",
abstract = "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.",
keywords = "London Stock Exchange, trading",
author = "Kojo Menyah and Krishna Paudyal",
year = "1996",
doi = "10.1111/j.1475-6803.1996.tb00220.x",
language = "English",
volume = "19",
pages = "377--394",
journal = "Journal of Financial Research",
issn = "0270-2592",
number = "3",

}

The determinants and dynamics of bid-ask spreads on the London stock exchange. / Menyah, Kojo; Paudyal, Krishna.

In: Journal of Financial Research, Vol. 19, No. 3, 1996, p. 377-394.

Research output: Contribution to journalArticle

TY - JOUR

T1 - The determinants and dynamics of bid-ask spreads on the London stock exchange

AU - Menyah, Kojo

AU - Paudyal, Krishna

PY - 1996

Y1 - 1996

N2 - 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.

AB - 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.

KW - London Stock Exchange

KW - trading

UR - http://www.scopus.com/inward/record.url?scp=0000603515&partnerID=8YFLogxK

U2 - 10.1111/j.1475-6803.1996.tb00220.x

DO - 10.1111/j.1475-6803.1996.tb00220.x

M3 - Article

VL - 19

SP - 377

EP - 394

JO - Journal of Financial Research

T2 - Journal of Financial Research

JF - Journal of Financial Research

SN - 0270-2592

IS - 3

ER -