Date of Award

1989

Document Type

Dissertation

Degree Name

Doctor of Philosophy (PhD)

Department

Finance (Business Administration)

First Advisor

Gary C. Sanger

Abstract

The presence of the bid-ask spread causes equilibrium prices to deviate from transaction prices. More importantly, the components of the spread--the order component, the inventory component, and the information component--have different impacts on transaction prices. In general, the order and the inventory components induce negative correlation in successive transaction price changes. On the other hand, transaction prices will form a martingale if only the information component exists. This dissertation is composed of three related essays that utilize this general relationship between transaction prices and the components of the spread. The first essay employs a cross-sectional analysis that relates components of the spread (costs of specialists) to measures of market activity, risk, and information risk. Primary results indicate that information component is positively related to transaction size and insider holdings. The order component is positively associated with number of transactions. Institutional holdings is negatively related to the order and the inventory components. The second essay gives empirical evidence that trading activity, price variability, information component are higher in the opening transactions. On the other hand, order component, inventory component, and a measure of the transaction cost are estimated to be lower in the opening. These results give support to the importance of liquidity trading and the role of transaction costs. For the last trading hour, there are significant changes in trading activity and price variability without significant changes in components of spread, which is consistent with the previous finding of a positive relationship between volume and price changes. Some problems remain in the estimation of components of the spread. Therefore, caution must be taken with respect to results provided in essay one and two. A model that relates components of order imbalances (net volumes) and components of the spread is established in the third essay. The main result highlights the potentially important role of order imbalances in the information process. That is, variations in order imbalances give information concerning the degree of informational asymmetry in financial markets.

Pages

175

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