Relation between Bid-Ask Spread, Impact and Volatility in Order-Driven Markets

Abstract: We show that the cost of market orders and the profit of infinitesimal market-making or -taking strategies can be expressed in terms of directly observable quantities, namely the spread and the lag-dependent impact function. Imposing that any market taking or liquidity providing strategies is at best marginally profitable, we obtain a linear relation between the bid-ask spread and the instantaneous impact of market orders, in good agreement with our empirical observations on electronic markets. We then use this relation to justify a strong, and hitherto unnoticed, empirical correlation between the spread and the volatility per trade, with R2s exceeding 0.9. This correlation suggests both that the main determinant of the bid-ask spread is adverse selection, and that most of the volatility comes from trade impact. We argue that the role of the time-horizon appearing in the definition of costs is crucial and that long-range correlations in the order flow, overlooked in previous studie

Object Details

• Location: Deutsche Nationalbibliothek Frankfurt am Main
• Extent: Online-Ressource
• Language: Englisch
• Notes: Postprint ; begutachtet (peer reviewed) ; In: Quantitative Finance ; 8 (2007) 1 ; 41-57

Classification and Topics

• Classification: Wirtschaft

Contributors, Places and Time

• Event: Veröffentlichung
• (where): Mannheim
• (when): 2007
• Creator: Bouchaud, Jean-Philippe ; Vettorazzo, Michele ; Kockelkoren, Julien ; Wyart, Matthieu ; Potters, M

Further information

• DOI: 10.1080/14697680701344515
• URN: urn:nbn:de:0168-ssoar-221056
• Rights: Open Access unbekannt; Open Access; Der Zugriff auf das Objekt ist unbeschränkt möglich.
• Last update: 25.03.2025, 1:41 PM CET