Electronic Communication Networks, Market Makers, and the Components of the Bid-Ask Spread

40 Pages Posted: 27 Oct 2007 Last revised: 1 Sep 2014

See all articles by Phillip R. Daves

Phillip R. Daves

University of Tennessee, Knoxville - Department of Finance

T. Shawn Strother

University of Nebraska-Lincoln

James W. Wansley

University of Tennessee

Date Written: September 1, 2008

Abstract

We investigate why trading costs through Electronic Communication Networks (ECNs) are lower than trading costs with market makers through estimating the components of the bid-ask spread. Additionally, we show how the composition and size of bid-ask spreads change with the market environment. We find the adverse selection cost component of the bid-ask spread to be lower when ECNs are alone at the inside compared to when market makers are alone at the inside. The magnitude or size of the inside spread is largest during periods of high volatility but smallest when stock returns approach zero.

Keywords: ECNs, Bid-Ask Spread, Market Microstructure, Alternative Trading Systems

JEL Classification: G10, G14

Suggested Citation

Daves, Phillip R. and Strother, Timothy Shawn and Wansley, James W., Electronic Communication Networks, Market Makers, and the Components of the Bid-Ask Spread (September 1, 2008). Available at SSRN: https://ssrn.com/abstract=1024867 or http://dx.doi.org/10.2139/ssrn.1024867

Phillip R. Daves

University of Tennessee, Knoxville - Department of Finance ( email )

Knoxville, TN 37996
United States

Timothy Shawn Strother (Contact Author)

University of Nebraska-Lincoln ( email )

Lincoln, NE 68588-0490
United States

HOME PAGE: http://www.unl.edu

James W. Wansley

University of Tennessee ( email )

428 Stokely Management Center
Knoxville, TN 37996
United States

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