DETERMINANTS OF THE COMPONENTS OF THE BIDASK SPREAD ON THE LSE

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DETERMINANTS OF THE COMPONENTS OF THE BID-ASK
SPREAD ON THE LSE

• Dr. Evangelos GIOUVRIS
• School of Management
• Royal Holloway, University of London

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MOTIVATION

• Changes in trading systems
• Floor trading to electronic trading
• Batch trading (discrete time) to continuous
• Quote driven (obligatory market making) to order
  driven e.g FTSE100 stocks
• Quote driven to hybrid e.g FTSE250 stocks

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GENERIC RESEARCH QUESTION

• How do changes in trading systems affect
  information dissemination, risk perception and as
  a consequence the cost components of the bid-ask
  spread?

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BID-ASK SPREAD THEORY (1)

• Spread has three components inventory, order
  processing and asymmetric info
• Stoll (1989) decomposes spread making the
  following assumptions
• The market is informationally efficient so that
  expected price changes are independent of current
  and past information.
• The bid-ask spread is constant over time and all
  transactions occur at the highest bid or the
  lowest ask
• The proportions of bid-ask spread components are
  the same for all securities

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BID-ASK SPREAD THEORY (2)

• CRITICISM spread components are biased as a
  result of the existence of positive
  autocorrelation in returns which leads to a
  downwards bias in the estimation of the realised
  spread
• George.J, Kaul.G Nimalendran.M (1991) correct
  correct for this by estimating returns based on
  transaction prices and bid to bid
• Kim Ogden improve by using mid-quotes

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RESEARCH HYPOTHESES

• H1 the asymmetric component is higher under a
  quote-driven trading regime and lower under an
  order-driven trading regime
• H2 the asymmetric information component of the
  spread does not change between quote driven and
  hybrid markets.
• H3 volatility appears to have a stronger impact
  on both cost components under a quote driven
  regime but reduces significantly under an order
  driven regime (FTSE100).
• H4 volatility appears to have the same impact on
  the cost components of the spread under a quote
  driven and a hybrid market. (FTSE250)

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COST COMPONENT REGRESSIONS

• Si2-cov(RDi,tRDi,t-1)1/2
• Si?0?1SQi?t
• Si?0?1Di?2SQi?3(DiSQi)?t (GKN regression,
  difference between transaction prices and
  subsequent bid quotes)
• Si?0?1Di?2SQi?3(DiSQi)?t (KO regression,
  difference between transactions prices and
  mid-quotes )
• Si?0?1Di?2SQi?3(Di(1/TSSQ2i)1/2)?t (KO
  regression with KO estimator)

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COST COMPONENTS OF THE BID-ASK SPREAD FOR FTSE100
STOCKS
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COST COMPONENTS OF THE BID-ASK SPREAD FOR FTSE250
STOCKS
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DETERMINANTS OF COST COMPONENTS REGRESSIONS

• closing spreadit a0 a1Di ?0NTit ?1(DiNTit)
  ?0TVit ?1(DiTVit) ?0VOLit ?1(DiVOLit) ?it
• spread(every trade) it a0 a1Di ?0TVit
  ?1(DiTVit) ?0VOLit ?1(DiVOLit) ?it
• asymmetric informationit a0 a1Di ?0NTit
  ?1(DiNTit) ?0TVit ?1(DiTVit) ?0VOLit
  ?1(DiVOLit) ?it
• order processingit a0 a1Di ?0NTit
  ?1(DiNTit) ?0TVit ?1(DiTVit) ?0VOLit
  ?1(DiVOLit) ?it

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REGRESSION OF FTSE100 ALL STOCKS ON NUMBER OF
TRADES (NT), TRADING VOLUME (TV) AND VOLATILITY
(VOL) UNDER SEAQ AND SETS
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REGRESSION OF FTSE250 ALL STOCKS ON NUMBER OF
TRADES (NT), TRADING VOLUME (TV) AND VOLATILITY
(VOL) UNDER SEAQ AND SETSMM