This paper aims to investigate the performance of estimators of the bid-ask spread in a wide range of circumstances and sampling frequencies. The bid-ask spread is important for many reasons. Because spread data are not always available, many methods have been suggested for estimating the spread. Existing papers focus on the performance of the estimators either under ideal conditions or in real data. The gap between ideal conditions and the properties of real data are usually ignored. The consistency of the estimates across various sampling frequencies is also ignored.
The estimators and the possible errors are analysed theoretically. Then we perform simulation experiments, reporting the bias, standard deviation and root mean square estimation error of each estimator. More specifically, we assess the effects of the following factors on the performance of the estimators: the magnitude of the spread relative to returns volatility, randomly varying of spreads, the autocorrelation of mid-price returns and mid-price changes caused by trade directions and feedback trading.
The best estimates come from using the highest frequency of data available. The relative performance of estimators can vary quite markedly with the sampling frequency. In small samples, the standard deviation can be more important to the estimation error than bias; in large samples, the opposite tends to be true.
There is a conspicuous lack of simulation evidence on the comparative performance of different estimators of the spread under the less than ideal conditions that are typical of real-world data. This paper aims to fill this gap.
Bleaney, M. and Li, Z. (2015), "The performance of bid-ask spread estimators under less than ideal conditions", Studies in Economics and Finance, Vol. 32 No. 1, pp. 98-127. https://doi.org/10.1108/SEF-04-2014-0075
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