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A Simple Model Of Bid‐Ask Spread And Search

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  • Abdullah Yavaş

Abstract

This paper analyzes a simple search model of market making in which the agents can choose between searching for a trading partner or trading through the market‐maker. Explicit solutions for the equilibrium search intensities and the bid‐ask spread have been provided. Equilibrium search intensities and the bid‐ask spread reflect the strategic interaction between the agents and the market‐maker: an increase in the bid‐ask spread results in higher search intensities. The bid‐ask spread, on the other hand, reacts negatively to an increase in the search intensities (due to lower search costs, higher efficiency of search, or higher gains from a match). It is also shown that the introduction of a market‐maker increases the seller's reservation price and decreases the buyer's reservation price, hence narrowing the price dispersion.

Suggested Citation

  • Abdullah Yavaş, 1993. "A Simple Model Of Bid‐Ask Spread And Search," Review of Financial Economics, John Wiley & Sons, vol. 2(2), pages 73-84, March.
    • Handle: RePEc:wly:revfec:v:2:y:1993:i:2:p:73-84
    DOI: 10.1002/j.1873-5924.1993.tb00566.x
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    References listed on IDEAS

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