The Components of the Bid-Ask Spread: A General Approach

Roger D Huang and Hans Stoll

The Review of Financial Studies, 1997, vol. 10, issue 4, 995-1034

Abstract: A simple time-series market microstructure model is constructed within which existing models of spread components are reconciled. We show that existing models fail to decompose the spread into all its components. Two alternative extensions of the simple model are developed to identify all the components of the spread and to estimate the spread at which trades occur. The empirical results support the presence of a large order processing component and smaller, albeit significant, adverse selection and inventory components The spread components differ significantly according to trade size and are also sensitive to assumptions about the relation between orders and trades. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

Date: 1997
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