An Extended Model of Effective Bid-Ask Spread

In this paper we present an extended model for the estimation of effective bid-ask spread that improves the existing models and offers a new direction of generalisation. The quoted bid-ask spread represents the prices available at a given time for transactions only up to some relatively small amount. Moreover, it is observed that large trades are usually made at "worse" prices. Thus, we extend Roll's model to include multiple spreads of different sizes and their associated probabilities. Bayesian model estimation and comparison methods are used to assess the fit of the model to a time series of one-year corporate bond transaction data