Evaluating spread models with a basket security

Patricia Chelley-Steeley*, Keebong Park

*Corresponding author for this work

Research output: Contribution to journalArticle

Abstract

In this article we evaluate the most widely used spread decomposition models using Exchange Traded Funds (ETFs). These funds are an example of a basket security and allow the diversification of private information causing these securities to have lower adverse selection costs than individual securities. We use this feature as a criterion for evaluating spread decomposition models. Comparisons of adverse selection costs for ETF's and control securities obtained from spread decomposition models show that only the Glosten-Harris (1988) and the Madhavan-Richardson-Roomans (1997) models provide estimates of the spread that are consistent with the diversification of private information in a basket security. Our results are robust even after controlling for the stock exchange. © 2011 Copyright Taylor and Francis Group, LLC.

Original languageEnglish
Pages (from-to)259-283
Number of pages25
JournalApplied Financial Economics
Volume22
Issue number4
Early online date20 Oct 2011
DOIs
Publication statusPublished - 2012

Keywords

  • exchange traded-funds
  • market microstructure
  • spread decomposition

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