Posted versus effective spreads. Good prices or bad quotes?

Mitchell A. Petersen; David Fialkowski

doi:10.1016/0304-405X(94)90034-5

Posted versus effective spreads. Good prices or bad quotes?

Mitchell A. Petersen^*, David Fialkowski

^*Corresponding author for this work

Finance

Research output: Contribution to journal › Article › peer-review

156 Scopus citations

Abstract

When trades are executed inside the posted bid-ask spread, the posted spread is no longer an accurate measure of transactions costs faced by investors. Using two samples of market orders, one based on orders submitted by retail brokers and one based on orders submitted electronically to the NYSE, we document a significant difference between the posted spread and the effective spread paid by investors. For most orders, the effective spread averages half the posted spread. In addition, when the posted spread widens, only 10 to 22% of the increase appears in the effective spread. These results have significant implications for any empirical work that uses the posted spread as a measure of the cost of trading. Our findings also document a significant difference in the expected execution price across exchanges. This finding is robust to controls for the type of order, and implies that U.S. equity markets are not completely integrated.

Original language	English (US)
Pages (from-to)	269-292
Number of pages	24
Journal	Journal of Financial Economics
Volume	35
Issue number	3
DOIs	https://doi.org/10.1016/0304-405X(94)90034-5
State	Published - Jun 1994

Funding

*Petersen acknowledges financial support from the Center for Research in Security Prices at the University of Chicago. We would like to thank William Abrams, Bob Anstiss, Dave Belding, Beverly Clingan, Roger Hendrick, and Terence Meehan and seminar participants at London Business School, Northwestern University, Southern Methodist University, University of Chicago, and University of Florida for many useful insights. The constructive criticism of Jerold Warner (the editor) and Michael Barclay (the referee) have significantly improved the paper. We express our appreciation for very efficient programming by Greg May and Paul Ho. The views in this paper are those of the authors and do not necessarily reflect the views of the institutions discussed, or of CRSP.

Keywords

Effective bid-ask spread
Price improvement

ASJC Scopus subject areas

Accounting
Finance
Economics and Econometrics
Strategy and Management

Access to Document

10.1016/0304-405X(94)90034-5

Cite this

@article{bc52253844fe405abdcd596af21d39c9,

title = "Posted versus effective spreads. Good prices or bad quotes?",

abstract = "When trades are executed inside the posted bid-ask spread, the posted spread is no longer an accurate measure of transactions costs faced by investors. Using two samples of market orders, one based on orders submitted by retail brokers and one based on orders submitted electronically to the NYSE, we document a significant difference between the posted spread and the effective spread paid by investors. For most orders, the effective spread averages half the posted spread. In addition, when the posted spread widens, only 10 to 22% of the increase appears in the effective spread. These results have significant implications for any empirical work that uses the posted spread as a measure of the cost of trading. Our findings also document a significant difference in the expected execution price across exchanges. This finding is robust to controls for the type of order, and implies that U.S. equity markets are not completely integrated.",

keywords = "Effective bid-ask spread, Price improvement",

author = "Petersen, {Mitchell A.} and David Fialkowski",

note = "Funding Information: *Petersen acknowledges financial support from the Center for Research in Security Prices at the University of Chicago. We would like to thank William Abrams, Bob Anstiss, Dave Belding, Beverly Clingan, Roger Hendrick, and Terence Meehan and seminar participants at London Business School, Northwestern University, Southern Methodist University, University of Chicago, and University of Florida for many useful insights. The constructive criticism of Jerold Warner (the editor) and Michael Barclay (the referee) have significantly improved the paper. We express our appreciation for very efficient programming by Greg May and Paul Ho. The views in this paper are those of the authors and do not necessarily reflect the views of the institutions discussed, or of CRSP.",

year = "1994",

month = jun,

doi = "10.1016/0304-405X(94)90034-5",

language = "English (US)",

volume = "35",

pages = "269--292",

journal = "Journal of Financial Economics",

issn = "0304-405X",