recent developments in high frequency financial ... - Index of

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comparability across stocks, we compute effective and realized spreads relative to
the midquote prevailing at the time of the trade. Analyzing effective and realized
spreads is a straightforward way to assess and compare transaction costs and
adverse selection effects across stocks or trading venues. The realized spread can
be viewed as a transaction costs measure that is purged of informational effects
while the difference of effective and realized spread (referred to as price impact) is
a natural measure for the amount of informational content of the order flow. 8
Average effective spreads range from 0.04% to 0.13%. Realized spreads are
considerably smaller. This implies that price impacts, computed as the difference
between effective and realized spreads, are relatively large. In other words, a large
fraction of the spread is due to informational order flow. This is not an unexpected
result. In an open automated auction market there is no justification for inventory
costs associated with market making or monopolistic power of a market maker, the
other factors that may explain the spread. Furthermore, order submission fees, i.e.
operational costs, are very small.
Table 1 shows that there is a considerable variation of price impacts, market
capitalization and trading activity across stocks. The Spearman rank correlation
between market capitalization and price impacts is −0.88 (p-value