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Search Costs: The Neglected Spread Component
Mark D. Flood Federal Housing Finance Agency Ronald Huisman Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE) Kees C. G. Koedijk Tilburg University - Department of Finance Richard K. Lyons University of California, Berkeley; National Bureau of Economic Research (NBER) January 29, 1998 Abstract: This paper examines trading costs in markets where dealers search for price quotes (such as multiple-dealer equity markets and foreign exchange). Using an experimental market, we compare four popular models for estimating effective spreads. The theoretical implications of 'bid-ask bounce' are borne out with remarkable accuracy in the time series of transaction prices. More important, the cost of bilateral price search is a significant component of the effective spread (roughly 40 percent using the Roll (1984) measure). These search costs are a distinct component of the spread that has not been considered in the literature.
JEL Classifications: G10, G14, G15 Working Paper SeriesDate posted: February 11, 1998 ; Last revised: August 04, 1998Suggested CitationContact Information
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