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Relative spread and price discovery

Author

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  • Aldrich, Eric M.
  • Lee, Seung
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.

Suggested Citation

  • Aldrich, Eric M. & Lee, Seung, 2018. "Relative spread and price discovery," Journal of Empirical Finance, Elsevier, vol. 48(C), pages 81-98.
    • Handle: RePEc:eee:empfin:v:48:y:2018:i:c:p:81-98
    DOI: 10.1016/j.jempfin.2018.06.007
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    References listed on IDEAS

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    1. Josef Brada & Harry Ernst & John Van Tassel, 1966. "Letter to the Editor—The Distribution of Stock Price Differences: Gaussian After All?," Operations Research, INFORMS, vol. 14(2), pages 334-340, April.
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    Cited by:

    1. Hagströmer, Björn, 2021. "Bias in the effective bid-ask spread," Journal of Financial Economics, Elsevier, vol. 142(1), pages 314-337.

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    More about this item

    Keywords

    Market microstructure; Market design; High-frequency trading;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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