medium · Market Microstructure mmf-core

What happens to the bid-ask spread and to the *speed of price discovery* (how fast quotes converge to the true value), and why?

1. The spread widens and price discovery accelerates, because each trade now carries more information, so quotes update more aggressively per trade while the maker demands more compensation for adverse selection
2. The spread narrows and price discovery slows, because a larger fraction of informed traders crowds out uninformed noise traders, so the maker faces less adverse selection and less inventory risk per trade
3. The spread is unchanged and price discovery accelerates, because under Glosten-Milgrom the spread depends only on the volatility of asset value, while the information content of each order rises sharply
4. The spread widens and price discovery slows, because the market maker must protect against informed order flow by quoting a much wider spread and therefore revises quotes more cautiously after each individual trade

Sign up free to see the explanation and track your rank →