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The Volatility of Bid-Ask Spreads

Financial Management, 2015, 44(4) 851-874

39 Pages Posted: 17 May 2013 Last revised: 1 Feb 2016

Benjamin M. Blau

Utah State University - Huntsman School of Business

Ryan J. Whitby

Utah State University - Huntsman School of Business

Date Written: 2015

Abstract

This paper provides evidence that supports the original hypothesis of Chordia, Subrahmanyam, and Ashuman (2001) that greater variability in liquidity should lead to higher expected returns. While prior research has often found a negative relation between the volatility of liquidity and expected stock returns, we find that the volatility of the bid-ask spread is positively related to future returns. The average risk-adjusted return for stocks in the highest spread volatility quintile is around 1.7 percent per month, with returns from High-Low quintiles as high as 2.7 percent per month. Furthermore, the spread volatility premium is robust to a variety of multivariate tests that control for the market risk factor, SMB, HML, momentum, and illiquidity risk. Our findings provide support for the hypothesis that variability in liquidity affects expected returns and is an important component of illiquidity.

Keywords: Spread Volatility, Illiquidity Premia

Suggested Citation

Blau, Benjamin M. and Whitby, Ryan J., The Volatility of Bid-Ask Spreads (2015). Financial Management, 2015, 44(4) 851-874. Available at SSRN: https://ssrn.com/abstract=2266039 or http://dx.doi.org/10.2139/ssrn.2266039

Benjamin M. Blau (Contact Author)

Utah State University - Huntsman School of Business ( email )

3500 Old Main Hill
Logan, UT 84322
United States

Ryan J. Whitby

Utah State University - Huntsman School of Business ( email )

3500 Old Main Hill
Logan, UT 84322-3500
United States
435.797.9495 (Phone)

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