An Extended Model of Serial Covariance Bid-Ask Spreads

Abstract

This paper presents a generalized serial covariance spread pricing model that unifies_x000D_ and improves existing spread models. We analyze three cost components of spread: order processing, adverse information, and inventory holding costs. We modify Stoll’s (1989) model by incorporating a two-period conditional probability trading model to derive a new_x000D_ spread estimator. We propose a methodology to estimate the input parameters. We then show_x000D_ this extended model potentially avoids some of the limitations associated with earlier models.