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Forecasting the intra-day effective bid ask spread by combining density forecasts

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  • Malick Fall
  • Waël Louhichi
  • Jean Laurent Viviani

Abstract

The bid-ask spread refers to the tightness dimension of liquidity and can be used as a proxy for transaction costs. Despite the importance of the bid-ask spread in the financial literature, few studies have investigated its forecastability. We propose a new methodology to predict the bid ask spread by combining density forecasts of two types of models: Multiplicative Errors Models and ARMA-GARCH models. Our method is employed to predict the effective intra-day bid-ask spread series of all shares pertaining to the CAC40 index. Using a one-step-ahead out-of-sample framework, we resort on the Model Confidence Set procedure to classify models and we found that the proposed model appears to beat all the benchmark specifications.

Suggested Citation

  • Malick Fall & Waël Louhichi & Jean Laurent Viviani, 2021. "Forecasting the intra-day effective bid ask spread by combining density forecasts," Applied Economics, Taylor & Francis Journals, vol. 53(50), pages 5772-5792, October.
    • Handle: RePEc:taf:applec:v:53:y:2021:i:50:p:5772-5792
    DOI: 10.1080/00036846.2021.1929821
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