Trading Mechanisms and the Components of the Bid-Ask Spread



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    • Affleck-Graves is from the University of Notre Dame, Hedge is from the University of Connecticut, and Miller is from Northern Illinois University. We appreciate the comments and suggestions made by Ben Branch, Robert Daigler, Thomas George, Bill McDonald, Rick Mendenhall, Cathy Niden, Hans Stoll, and seminar participants at the University of Connecticut, University of Massachusetts, Amherst, University of Notre Dame, and the 1990 Financial Management Association Meeting. We also thank Rene Stulz (Managing Editor), Stephen Buser, and David Mayers (Co-Editors), and two anonymous reviewers for helpful comments and suggestions. Finally, we thank the American Stock Exchange, particularly Marcia J. Mayor, for providing the data.




We compare the relative magnitudes of the components of the bid-ask spread for New York Stock Exchange (NYSE)/American Stock Exchange (AMEX) stocks to those of National Association of Securities Dealers Automated Quotations (NASDAQ)/National Market System (NMS) stocks. We find that the order-processing cost component is smaller, and the adverse selection component is greater on the NYSE/AMEX trading systems than on the NASDAQ/NMS system. The inventory holding component is also greater for exchange-traded stocks than for NASDAQ/NMS stocks, but this may be attributable to differences in the characteristics of the firms whose stocks trade on the respective systems.