Effects of Bid-Ask Spreads and Price Discreteness on Stock Returns

Ajay R. Dravid

Rodney L. White Center for Financial Research Working Papers from Wharton School Rodney L. White Center for Financial Research

Abstract: This paper shows that the effects of bid-ask spreads and price discreteness on observed stock returns are related to stock price level, properties of the bid-ask spread and the nature of the rounding process. Using a mole similar to Harris (1990), we derive robust Taylor series approximations relating the moments of observed stock returns to the underlying true return moments. Previous results from the literature are shown to be simple special cases of our results. We suggest explanations for seemingly anomalous empirical results such as the average non-January size effect, changes in post-split stock return volatility and the serial correlation of stock returns.

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