The presence of traders with superior information leads to a positive bid-ask spread even when the specialist is risk-neutral and makes zero expected profits. The resulting transaction prices convey information, and the expectation of the average spread squared times volume is bounded by a number that is independent of insider activity. The serial correlation of transaction price differences is a function of the proportion of the spread due to adverse selection. A bid-ask spread implies a divergence between observed returns and realizable returns. Observed returns are approximately realizable returns plus what the uninformed anticipate losing to the insiders.
REF propose that the trading of informed traders who have superior information leads to a positive bid-ask spread, even when the specialist is risk neutral and makes zero expected profits.
BID, ASK AND' TRANSACTION PRICES IN A SPECIALIST MARKET WITH HETEROGENEOUSLY INFORMED TRADERS*
Journal of Financial Economics
Economics