Search Costs: The Neglected Spread Component
22 Pages Posted: 11 Feb 1998
Date Written: January 29, 1998
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: Suggested Citation