A Simple Implicit Measure of the Effective Bid-Ask Spread in an Efficient Market

Abstract

In an efficient market, the fundamental value of a security fluctuates randomly. However, trading costs induce negative serial dependence in successive observed market price changes. In fact, given market efficiency, the effective bid-ask spread can be measured bySpread=2⁢−covwhere “cov” is the first-order serial covariance of price changes. This implicit measure of the bid-ask spread is derived formally and is shown empirically to be closely related to firm size.