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Bid, ask and transaction prices in a specialist market with heterogeneously informed traders

1985; Elsevier BV; Volume: 14; Issue: 1 Linguagem: Inglês

10.1016/0304-405x(85)90044-3

1879-2774

Lawrence R. Glosten, Paul Milgrom,

Auditing, Earnings Management, Governance

The presence of traders with superior information leads to a positive bid-ask spread even when the specialist is risk-neutral and makes zero expected profits. The resulting transaction prices convey information, and the expectation of the average spread squared times volume is bounded by a number that is independent of insider activity. The serial correlation of transaction price differences is a function of the proportion of the spread due to adverse selection. A bid-ask spread implies a divergence between observed returns and realizable returns. Observed returns are approximately realizable returns plus what the uninformed anticipate losing to the insiders.