A SHARP Model of Bid-Ask Spread Forecasts

Abstract

This paper proposes an accurate, parsimonious and fast-to-estimate forecasting model for integer-valued time series with long memory and seasonality. The modelling is achieved through an autoregressive Poisson process with a predictable stochastic intensity that is determined by two factors: a seasonal intraday pattern and a heterogeneous autoregressive component. We call the model SHARP, which is an acronym for seasonal heterogeneous autoregressive Poisson. We also present a mixed-data sampling extension of the model, which adopts the historical information flow more efficiently and provides the best (among all the models considered) forecasting performances, empirically, for the bid-ask spreads of NYSE equity stocks. We conclude by showing how bid-ask spread forecasts based on the SHARP model can be exploited in order to reduce the total cost incurred by a trader who is willing to buy or sell a given amount of an equity stock.

Keywords: bid-ask spread, forecasting, liquidity, long-memory, seasonality, integer-valued, stochastic processes

JEL Classification: C02, C58, C87, C53