Relation between Bid-Ask Spread, Impact and Volatility in Double Auction Markets

Matthieu Wyart, Jean-Philippe Bouchaud, Julien Kockelkoren, Marc Potters () and Michele Vettorazzo
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Matthieu Wyart: CEA Saclay;
Jean-Philippe Bouchaud: Science & Finance, Capital Fund Management
Julien Kockelkoren: Capital Fund Management

No 500067, Science & Finance (CFM) working paper archive from Science & Finance, Capital Fund Management

Abstract: We argue that on electronic markets, limit and market orders should have equal effective costs on average. This symmetry implies a linear relation between the bid-ask spread and the average impact of market orders. Our empirical observations on different markets are consistent with this hypothesis. We then use this relation to justify a simple, and hitherto unnoticed, proportionality relation between the spread and the volatility_per trade_. We provide convincing empirical evidence for this relation. This suggests that the main determinant of the bid-ask spread is adverse selection, if one considers that the volatility per trade is a measure of the amount of `information' included in prices at each transaction. Symmetry between market and limit orders stems from the self-organization of liquidity in electronic markets. Our results appear to hold approximately on liquid specialist markets as well, although the spread is significantly larger.

Date: 2006-03
New Economics Papers: this item is included in nep-cfn and nep-fmk
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Citations: View citations in EconPapers (11)

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Working Paper: Relation between Bid-Ask Spread, Impact and Volatility in Double Auction Markets (2007)
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