Information Asymmetry and the Dealer's Bid-Ask Spread: A Case Study of Earnings and Dividend Announcements




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    • University of Houston and University of Miami, respectively. The authors would like to thank members of the Finance faculties at the Universities of Houston and Florida and an anonymous referee of this Journal for helpful comments and suggestions. Special thanks are due A. A. Heggestad, M. P. Narayanan, R. Pettit, M. Rzepczynski, and K. Sawyer. We are especially grateful to Ron Singer for his substantial contributions to the style and substance of this paper.


Recent theoretical work on the bid-ask spread asserts that the dealer should widen the bid-ask spread when he or she suspects that the information advantage possessed by informed traders has increased. Thus, the dealer's spread can be employed to test for an increase in information asymmetry prior to an anticipated information event. In this paper, the method is applied to earnings and dividend announcements, which have been documented to be information events. The authors study three groups of announcements: (a) joint announcements—i.e., earnings and dividend announcements that are made on the same day, (b) initial (first) announcements—earnings or dividend announcements that were not preceded by another announcement in the prior thirty days, and (c) following (second) announcements—those announcements that follow the first announcement by at least ten days but by no more than thirty days. The authors find a strong increase in information asymmetry only before the second announcements and virtually no increase before the joint and first announcements. This is consistent with the hypothesis that there is, on average, normal information asymmetry before announcements, but that the dealer will suspect a nonroutine announcement (with an attendant increase in information asymmetry) when the second announcement is separated from the first by more than ten days. Other possible explanations for the results are discussed, and suggestions for future research are outlined.