Glosten–Milgrom Model
Market Microstructure glossary · Adverse Selection & Information Asymmetry
Definition
A model of spread determination in which competitive dealers set bid and ask prices equal to expected value conditional on sell and buy orders, respectively.
Glosten–Milgrom Model in plain English
Imagine you're buying a used bike from a stranger who might secretly know it's a lemon. To protect themselves, dealers in a market face the same worry: the person selling to them might know bad news, and the person buying might know good news. The Glosten–Milgrom model says a dealer sets the price they'll BUY at (the bid) a little low and the price they'll SELL at (the ask) a little high, each set to the fair value AFTER accounting for what your order itself reveals — because someone eager to buy is a hint the true value is higher, and vice versa. The gap between those two prices, the spread, isn't greed; it's the dealer's shield against traders who know more than they do.
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