Spread decomposition with common spread components

Thomas Henker, Martin Martens

Research output: Contribution to journalArticleResearchpeer-review

Abstract

Purpose – This paper aims to incorporate a market wide buying and selling pressure cost component into a spread decomposition model as spread cost component. Design/methodology/approach – The paper extends a commonly used trade indicator spread decomposition model to include a component common to all stocks of a specialist firm and a market wide component common to all stocks. Findings – Strong evidence is found that specialists consider this common factor cost component when they set bid and ask quotes. Some specialist firms also take the next logical step and specifically manage their firm wide stock inventories. The common factor is in percentage terms largest for securities with the highest trade frequencies. Research limitations/implications – The relative importance of the common factor spread component decreases as the pricing grid becomes finer, but remains highly significant under the decimal trading regime. Originality/value – This is the first study to document notsecurityspecific spread cost components that are common to all stocks for which a specialist firm makes markets and to all stocks in the market. Using the model it is shown that market wide uncertainty translates into spreads of individual securities.

Original languageEnglish
Pages (from-to)88-115
Number of pages28
JournalInternational Journal of Managerial Finance
Volume6
Issue number2
DOIs
Publication statusPublished - 6 Apr 2010
Externally publishedYes

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Decomposition
Costs
Common factors
Common component
Relative importance
Uncertainty
Grid
Bid
Logic
Pricing
Design methodology

Cite this

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Spread decomposition with common spread components. / Henker, Thomas; Martens, Martin.

In: International Journal of Managerial Finance, Vol. 6, No. 2, 06.04.2010, p. 88-115.

Research output: Contribution to journalArticleResearchpeer-review

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