ABSTRACT
Stoll (2003) separates bid-ask spread into three components: trade execution cost, inventory maintenance cost, and information asymmetry or adverse selection cost. e origin of trade execution cost is that traders cannot organize the market for themselves for regulatory reasons or because of externalities and so they turn to a special agent, who acts as a near-monopolist with respect to individual traders and can extract nonzero profi ts for his or her services (He and Wu, 2005). Inventory maintenance costs originate in the fact that market makers, to assure smooth execution of trades by market participants, hold their own portfolios of securities, which bear fi nancial risk. In the absence of a physical market maker, an electronic trading platform bears inventory risk as long as the exchange provides statutory guarantee of trade execution.
