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The Dynamics of Discrete Bid and Ask Quotes

Authors

  • Joel Hasbrouck

    1. Stern School of Business, New York University
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    • Professor of Finance, Stern School of Business, New York University. For comments on an earlier draft, I am indebted to James Angel, Darrell Duffie, James Hamilton, Mark Rubinstein, Neil Shephard, Matt Spiegel, and seminar participants at Cornell University, Georgetown University, New York University, Stanford University, the University of California at Berkeley, and the UCSD Conference on High Frequency Data. All errors are my own responsibility.

ABSTRACT

This paper presents an empirical microstructure model of bid and ask quotes that features discreteness, random costs of market making, and ARCH volatility effects. Applied to intraday quotes at 15-minute intervals for Alcoa (a randomly chosen Dow stock), the results show that quote exposure costs contain stochastic components that are persistent and large relative to the deterministic intraday “U” components. Analysis of the filtered estimates of the system suggest that bid and ask costs contain common components, and that these costs reflect risk as proxied by ARCH variance forecasts.

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