What Explains the Bid-Ask Spread Decline after Nasdaq Reforms?

• Main Authors: WU, Chunchi, He, Yan
• Format: text
• Language: English
• Published: Institutional Knowledge at Singapore Management University 2003
• Subjects: Business
• Online Access: https://ink.library.smu.edu.sg/lkcsb_research/792
• Institution: Singapore Management University

This paper examines whether the decrease in bid2010ask spreads on Nasdaq after the 1997 reforms is due to a decrease in market2010making costs and/or an increase in market competition for order flows. Unlike previous studies, we jointly examine how competition and trading costs affect bid2010ask spreads. In addition, we separate the effects of informed trading and liquidity costs on bid2010ask spreads. Informed trading cost is directly estimated for each Nasdaq stock using a Bayesian theoretic model. Empirical results show that market2010making costs and competition significantly affect bid2010ask spreads. The post2010reform decrease in bid2010ask spreads is largely due to both an increase in competition and a decrease in informed trading and liquidity costs on Nasdaq.