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Estimating the profit markup component of the bid-ask spread

Levin, E.J. and Wright, R.E. (2004) Estimating the profit markup component of the bid-ask spread. Quarterly Review of Economics and Finance, 44 (1). pp. 1-19. ISSN 1062-9769

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Abstract

In this paper the theoretical profit-maximising bid-ask spread, based in economic theory, is related to the excess demand curve (i.e., the difference between the slopes of the demand and supply curves), market concentration, and the degree of collusion. Empirical estimates of the slopes of the excess demand curves are substituted into this economic relationship in order to calculate the excess profit component of the bid-ask spread for all Financial Times-Stock Exchange 100-Share Index (FTSE100) stocks traded on the London Stock Exchange (LSE) in the period 1 August 1994 and 31 July 1995. The excess profit component in a Cournot-Nash equilibrium represents 11% of the observed bid-ask spread on average.