Relative Spread and Price Discovery

39 Pages Posted: 30 Apr 2016 Last revised: 10 May 2017

Eric M. Aldrich

University of California, Santa Cruz

Seung Lee

University of California, Santa Cruz

Date Written: November 21, 2016

Abstract

We establish the importance of relative minimum price increments for price discovery in the context of a single asset trading at diverse venues. Our model relates relative spreads to directed information flows and begets a set of testable implications. Although conventional wisdom dictates that futures prices lead equities, our model predicts the opposite should be true when particular relative price conditions hold for the bids and offers of each asset. We develop an empirical measure of price discovery which is suited to asynchronous, high-frequency financial data and test the model predictions. Empirical evidence strongly supports the relative spread mechanism.

Keywords: Market microstructure, market design, high-frequency trading

JEL Classification: G12, G14

Suggested Citation

Aldrich, Eric M. and Lee, Seung, Relative Spread and Price Discovery (November 21, 2016). Available at SSRN: https://ssrn.com/abstract=2772142

Eric Mark Aldrich (Contact Author)

University of California, Santa Cruz ( email )

Santa Cruz, CA 95064
United States
831-459-4247 (Phone)

HOME PAGE: http://ealdrich.com

Seung Lee

University of California, Santa Cruz ( email )

1156 High St
Santa Cruz, CA 95064
United States

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