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When Do Low-Frequency Measures Really Measure Effective Spreads? Evidence from Equity and Foreign Exchange Markets

Author

Listed:
  • Mohammad R
  • Filip Zikes
  • Itay Goldstein

Abstract

We present evidence that several popular low-frequency measures of effective spread suffer from a volatility-induced bias and that volatility is the primary driver of the variation of these liquidity proxies. Using data for U.S. equities and major foreign exchange rates, we show that the bias arises when the effective spread is small relative to volatility. We document that the bias has become more acute over time and show that volatility-biased measures fail to replicate some well-known results in empirical finance. We conclude by providing guidance on the choice of low-frequency measures in empirical applications.Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

Suggested Citation

  • Mohammad R & Filip Zikes & Itay Goldstein, 2023. "When Do Low-Frequency Measures Really Measure Effective Spreads? Evidence from Equity and Foreign Exchange Markets," The Review of Financial Studies, Society for Financial Studies, vol. 36(10), pages 4190-4232.
    • Handle: RePEc:oup:rfinst:v:36:y:2023:i:10:p:4190-4232.
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    More about this item

    Keywords

    C15; C58; G12; G20; F31;
    All these keywords.

    JEL classification:

    • C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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