Consistency between Predicted and Actual Bid-Ask Quote-Revisions




    Search for more papers by this author
    • Korea University and University of Houston, respectively. The first author was a faculty member at the University of Houston when this work was initiated. We would like to thank AMEX for making the data available to us. We would like to acknowledge helpful comments from our colleagues at the University of Houston, participants at the Texas A&M Symposium, and the Western Finance Association meetings in Seattle. In particular, we thank Rich Pettit, Ron Singer, Yakov Amihud, Kalman Cohen, Laura Starks, and Seha Tinic. Special thanks to the painstaking efforts of the referee whose suggestions have substantially improved the paper.


This paper employs a “transaction” data-base to study whether observed quote-revisions are consistent with those predicted by the adverse selection and inventory cost theories of the bid-ask spread. We find that actual quote-revisions are consistent with the theoretical prediction in only 25% of the cases. Furthermore, quote-revision patterns are found to be strongly dependent on the level of the outstanding spread and, to a lesser extent, on the transaction size. These systematic patterns, unrelated to the inventory cost and adverse selection theories, are consistent with the effect on quote-revisions of the limit order book and the minimum 1/8 price-change rule.