publication . Research . Preprint . Other literature type . Article . 1985

BID, ASK AND' TRANSACTION PRICES IN A SPECIALIST MARKET WITH HETEROGENEOUSLY INFORMED TRADERS*

Lawrence R. Glosten; Paul R. Milgrom;
Open Access English
  • Published: 01 Mar 1985
  • Publisher: Evanston, IL: Northwestern University, Kellogg School of Management, Center for Mathematical Studies in Economics and Management Science
Abstract
The presence of traders with superior information leads to a positive bid-ask spread even when the specialist is risk-neutral and makes zero expected profits. The resulting transaction prices convey information, and the expectation of the average spread squared times volume is bounded by a number that is independent of insider activity. The serial correlation of transaction price differences is a function of the proportion of the spread due to adverse selection. A bid-ask spread implies a divergence between observed returns and realizable returns. Observed returns are approximately realizable returns plus what the uninformed anticipate losing to the insiders.
Subjects
free text keywords: ddc:330, Financial economics, Bid–ask spread, Tick size, Dark liquidity, Market microstructure, Insider, Adverse selection, Economics, Bid price, Flash trading, Finance, business.industry, business
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