Lecture 5 Flashcards
What is the effective spread?
The effective spread is the difference between the prices at which the dealers actually buy and sell.
Is the effective spread the same as the quoted bid-ask spread?
NO they can be different.
How do effective spreads arise?
- Traders trade with dealer at prices inside the quote.
2. Dealers adjust their quotes between trades.
Why do dealers adjust spreads between trades?
As they observe the market
In the dealer market, dealer will set their bid-ask spread to achieve what?
To maximize their profits
How big the dealers spreads are depends on what?
How much competition is in the market.
When the spread of a dealer is narrow this means the market is?
Competitive dealers are trying to encourage traders to trade with them.
When the spread of a dealer is wide this means the market is?
To make more profit and recover the costs of doing business.
What is adverse selection in financial trading?
occurs when one trader with special information uses that information to her advantage at the expense of her counter party in trade
Kyle (1985) theoretical model describes:
the trading behavior of informed traders and uniformed market makers in an environment with noise traders and liquidity traders.
What kind of auction model is Kyle’s:
one-single price auction model
Who is in this one-single price auction?
- Single Dealer
- Many uniformed traders
- Single informed trader with perfect information
The dealers price function is related to what in the market?
Supply and Demand
the dealers pricing function is related to the supply and demand and further the dealer’s perception of what?
the dealer’s perception of sensitivity of the intrinsic value to volume
what does the dealer’s perception of sensitivity of the intrinsic value to volume mean?
that as a dealer they can observe the order flow when their is an increase in supply or demand then I can see that something has changed with the fundamental value of the security
If the dealer thinks the market is sensitive that means:
That the dealer believes there are a lot of informed traders