The components of the bid-ask spread in a limit-order market: Evidence from the Tokyo Stock Exchange

Ahn, Hee-Joon; Cai, Jun; Hamao, Yasushi; Ho, Richard Y. K.

This paper analyzes the components of the bid-ask spread in the limit-order book of the Tokyo Stock Exchange (TSE). While the behavior of spread components in U.S. markets has been extensively studied, little is known about the spread components in a pure limit-order market. We find that both the adverse selection and order handling cost components of the TSE exhibit U-shape patterns independently, in contrast to the findings of Madhavan, Richardson, and Roomans (1997) for U.S. stocks. On the TSE, there does not exist an upstairs market that allows large trades to be prenegotiated or certified as on the New York Stock Exchange (NYSE). This feature of the TSE provides a valuable opportunity to examine the relationship between trade size and spread components. Our results show that the adverse selection cost increases with trade size while order handling cost decreases with it.

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Academic Units
Center on Japanese Economy and Business
Center on Japanese Economy and Business, Graduate School of Business, Columbia University
Center on Japanese Economy and Business Working Papers, 197
Published Here
February 11, 2011