Estimating Actual Bid-Ask Spreads in Commodity Futures Markets

Various bid-ask spread estimators are applied to transaction data from LIFFE cocoa and coffee futures markets, and the resulting estimates are compared to observed actual bid-ask spreads. Results suggest that actual bid-ask spreads, which are not reported by most open-outcry futures markets, can be reasonably estimated using readily available transaction data. This is especially important since recent research seems to indicate that efforts to estimate effective spreads using data commonly available from futures markets have not been successful. Thus estimates of actual spreads can give market participants and researchers some idea of potential transaction costs. Accurate estimates of bid-ask spreads will also be needed to assess the relative efficiency of electronic versus open-outcry trading. Results indicate that estimators using averages of absolute price changes perform significantly better at estimating actual bid-ask spreads in futures markets than estimators using the covariance of successive price changes.