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Simple Nonparametric Estimators for the Bid-Ask Spread in the Roll Model

Xiaohong Chen (), Oliver Linton (), Stefan Schneeberger () and Yanping Yi ()
Additional contact information
Stefan Schneeberger: Dept. of Economics, Yale University
Yanping Yi: Shanghai University of Finance and Economics - School of Economics

No 2033, Cowles Foundation Discussion Papers from Cowles Foundation for Research in Economics, Yale University

Abstract: We propose new methods for estimating the bid-ask spread from observed transaction prices alone. Our methods are based on the empirical characteristic function instead of the sample autocovariance function like the method of Roll (1984). As in Roll (1984), we have a closed form expression for the spread, but this is only based on a limited amount of the model-implied identification restrictions. We also provide methods that take account of more identification information. We compare our methods theoretically and numerically with the Roll method as well as with its best known competitor, the Hasbrouck (2004) method, which uses a Bayesian Gibbs methodology under a Gaussian assumption. Our estimators are competitive with Roll's and Hasbrouck's when the latent true fundamental return distribution is Gaussian, and perform much better when this distribution is far from Gaussian. Our methods are applied to the E-mini futures contract on the S&P 500 during the Flash Crash of May 6, 2010. Extensions to models allowing for unbalanced order flow or Hidden Markov trade direction indicators or trade direction indicators having general asymmetric support or adverse selection are also presented, without requiring additional data.

Keywords: Characteristic function; Deconvolution; Flash Crash; Liquidity (search for similar items in EconPapers)
JEL-codes: C30 C32 G10 (search for similar items in EconPapers)
Pages: 51 pages
Date: 2016-03
New Economics Papers: this item is included in nep-ecm and nep-mst
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Working Paper: Simple Nonparametric Estimators for the Bid-Ask Spread in the Roll Model (2016) Downloads
Working Paper: Simple Nonparametric Estimators for the Bid-Ask Spread in the Roll Model (2016) Downloads
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