NON-STATIONARITY IN SPREADS: THE ROLE OF OPTIMAL LAG STRUCTURE

摘要

Mean-reversion of trade-to-trade spreads follows directly from an error correction quote adjustment process plus a random walk theory of the quote midpoint as an implicit efficient price. In such a model, buys and sells are equally likely, and the trade direction is informationless. With asymmetric information and strategic trading, however, order flow is serially correlated, and the spread incorporates a time-varying adverse selection component that conditions on trade direction or order flow imbalance. We test the mean reversion of spreads for NYSE stocks 1993-2006, and find that tick size reduction in 1997 and 2001 substantially reduced the incidence of mean-reverting NYSE spreads. This diminished resiliency of the NYSE book appears to result from the reduction in tick size relative to arbitrage threshold bounds. We document that these mean-reversion tests are very sensitive to lag structure misspecification by evaluating ten lags and best continuous lags (generalto- specific) against discontinuous optimal lags that minimize the AIC. Using a Monte Carlo experiment, we show that the power of the ADF test is always greater using optimal lags.