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 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 New York Stock Exchange 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