Specialists, Limit-Order Traders, and the Components of the Bid-Ask Spread

This study compares the components of the bid-ask spread estimated from quotes that reflect the trading interest of specialists with those estimated from limit-order quotes and all available quotes for a sample of New York Stock Exchange (NYSE) stocks. The results show that the adverse selection component of the spread estimated from specialist quotes is significantly smaller than the corresponding figures from limit-order quotes and entire quotes. We interpret this as evidence that NYSE specialists transfer at least a part of adverse selection costs to outsiders through the discretionary use of limit orders. Our results show that the estimation/interpretation of the components of the spread using quote data that include both specialist and limit-order interests is problematic. Copyright 2004 by the Eastern Finance Association.