Question

Determine how the bid-ask spreads of a stock will change under each of the following scenarios. Explain why in one or two sentences:

a) When the volumes of trades are high

b) When the volatility of equilibrium prices is high

c) When competition between market makers is high

Answer 1

Bid -ask spread is the difference between the price of the bid and ask of the security.

a) When the volume of the trades is high the difference between bid and ask would be very small as the large number of buyers and sellers are making the transaction, the price difference is very small because of high supply and high demand.

b) When the volatility of equilibrium price is high that can actually increase the bid-ask spread when the price is away from what it should be, so here the high volatility might increase the spread.

c) When there is high competition between market makers the volume of trading will be high, when the volume of trading is high then because of high supply and demand the spread will be very low.