Components of the Bid‐Ask Spread and the Statistical Properties of Transaction Prices

Abstract

ABSTRACT The bid‐ask spread can be decomposed into two parts: one part due to asymmetric information and the other part due to other factors such as monopoly power. The part due to asymmetric information attenuates statistical biases in mean return, variance, and serial covariance. Thus, using spread data to adjust for biases in return moments requires knowing not only the spread but the composition of the spread. Furthermore, any spread‐estimation procedure using transaction prices must estimate two spread components. On the other hand, the appropriateness of some previously suggested statistical corrections is independent of the spread composition.