Search Costs: The Neglected Spread Component

22 Pages Posted: 11 Feb 1998

See all articles by Mark D. Flood

Mark D. Flood

R. H. Smith School of Business, U. of Maryland

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)

Date Written: 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 Classification: G10, G14, G15

Suggested Citation

Flood, Mark D. and Huisman, Ronald and Koedijk, Kees G. and Lyons, Richard K., Search Costs: The Neglected Spread Component (January 29, 1998). Available at SSRN: https://ssrn.com/abstract=58693 or http://dx.doi.org/10.2139/ssrn.58693

Mark D. Flood

R. H. Smith School of Business, U. of Maryland ( email )

College Park
College Park, MD 20742
United States

Ronald Huisman (Contact Author)

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE) ( email )

P.O. Box 1738
3000 DR Rotterdam, NL 3062 PA
Netherlands

Kees G. Koedijk

Tilburg University - Department of Finance ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands
+31 13 4663048 (Phone)
+31 13 4662052 (Fax)

Richard K. Lyons

University of California, Berkeley ( email )

Haas School of Business
Berkeley, CA 94720
United States
510-642-1059 (Phone)
510-643-1420 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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