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Effects of Bid-Ask Spreads and Price Discreteness on Stock Returns

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  • Ajay R. Dravid

Abstract

This paper shows that the effects of bid-ask spreads and price discreteness on observed stock returns are related to stock price level, properties of the bid-ask spread and the nature of the rounding process. Using a mole similar to Harris (1990), we derive robust Taylor series approximations relating the moments of observed stock returns to the underlying true return moments. Previous results from the literature are shown to be simple special cases of our results. We suggest explanations for seemingly anomalous empirical results such as the average non-January size effect, changes in post-split stock return volatility and the serial correlation of stock returns.

Suggested Citation

  • Ajay R. Dravid, "undated". "Effects of Bid-Ask Spreads and Price Discreteness on Stock Returns," Rodney L. White Center for Financial Research Working Papers 06-91, Wharton School Rodney L. White Center for Financial Research.
    • Handle: RePEc:fth:pennfi:06-91
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    Cited by:

    1. Hautsch, Nikolaus & Pohlmeier, Winfried, 2001. "Econometric Analysis of Financial Transaction Data: Pitfalls and Opportunities," CoFE Discussion Papers 01/05, University of Konstanz, Center of Finance and Econometrics (CoFE).
    2. Rasika Yatigammana & Shelton Peiris & Richard Gerlach & David Edmund Allen, 2018. "Modelling and Forecasting Stock Price Movements with Serially Dependent Determinants," Risks, MDPI, vol. 6(2), pages 1-22, May.
    3. Hasbrouck, Joel, 1999. "Security bid/ask dynamics with discreteness and clustering: Simple strategies for modeling and estimation1," Journal of Financial Markets, Elsevier, vol. 2(1), pages 1-28, February.
    4. Joel Hasbrouck, 1998. "Security Bid/Ask Dynamics with Discreteness and Clustering: Simple Strategies for Modeling and Estimation," New York University, Leonard N. Stern School Finance Department Working Paper Seires 98-042, New York University, Leonard N. Stern School of Business-.

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