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Keywords:

  • Bid-ask Spread Decomposition;
  • Cross-Market Model;
  • Order-driven market;
  • Option Trade Indicator;
  • Information Asymmetry

Abstract

This paper develops a cross-market model to extend Huang and Stoll (1997) by utilizing information from trade flows in the options market. Empirical tests reveal a significant increase in the estimated adverse information component, which stays consistent irrespective of the degree of option leverage. Further, intraday variation in stock bid-ask spread components is affected by the stock trade size and the extent of imbalance in information-based option trades. Including the options market information in decomposition of the stock bid-ask spread enhances the quality of its estimation.