More documents from Bouchaud, Jean-Philippe; Vettorazzo, Michele; Kockelkoren, Julien; Wyart, Matthieu; Potters, M
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Relation between Bid-Ask Spread, Impact and Volatility in Order-Driven Markets
[journal article]
Bouchaud, Jean-Philippe; Vettorazzo, Michele; Kockelkoren, Julien; Wyart, Matthieu; Potters, M
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Please use the following Persistent Identifier (PID) to cite this document:http://nbn-resolving.de/urn:nbn:de:0168-ssoar-221056
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| Abstract | We show that the cost of market orders and the profit of infinitesimal market-making or -taking strategies can be expressed in terms of directly observable quantities, namely the spread and the lag-dependent impact function. Imposing that any market taking or liquidity providing strategies is at best marginally profitable, we obtain a linear relation between the bid-ask spread and the instantaneous impact of market orders, in good agreement with our empirical observations on electronic markets. We then use this relation to justify a strong, and hitherto unnoticed, empirical correlation between the spread and the volatility per trade, with R2s exceeding 0.9. This correlation suggests both that the main determinant of the bid-ask spread is adverse selection, and that most of the volatility comes from trade impact. We argue that the role of the time-horizon appearing in the definition of costs is crucial and that long-range correlations in the order flow, overlooked in previous studies, must be carefully factored in. We find that the spread is significantly larger on the NYSE, a liquid market with specialists, where monopoly rents appear to be present. |
| Classification | Public Finance |
| Free Keywords | Microstructure; Bid-ask spread; Impact; Liquidity |
| Document language | English |
| Publication Year | 2007 |
| Page/Pages | p. 41-57 |
| Journal | Quantitative Finance, 8 (2007) 1 |
| DOI | http://dx.doi.org/10.1080/14697680701344515 |
| Status | Postprint; peer reviewed |
| Licence | PEER Licence Agreement (applicable only to documents from PEER project) |
