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Volume 2, No. 1,
April 2003
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An Extended Model of
Serial Covariance Bid-Ask Spreads
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Dar-Hsin
Chen*
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Deparement of Banking and Finance,
Tamkang University, Taiwan
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Lloyd P.
Blenman
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Department
of Finance and Business Law, University of North
Carolina-Charlotte,U.S.A.
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Abstract
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This
paper presents a generalized serial covariance spread
pricing model that unifies and improves existing
spread models. We analyze three cost components of
spread: order processing, adverse information, and
inventory holding costs. We modify Stoll's (1989)
model by incorporating a two-period conditional
probability trading model to derive a new spread
estimator. We propose a methodology to estimate the
input parameters. We then show this extended model
potentially avoids some of the limitations associated
with earlier models.
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Key words
: bid-ask spread; implicit spread; tick
test
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JEL classification
: G10; D80
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