hard · Market Microstructure spread-econ
In the Stoll (1989) spread-decomposition framework, a market maker faces a stock whose realized daily volatility increases from 1% to 2%.
Holding the probability of an informed trader and inventory parameters constant, which two components of the quoted spread widen, and in what direction does the order-processing component move?
- Adverse-selection and inventory components widen; order-processing stays flat.
- Adverse-selection and order-processing components widen; inventory stays flat.
- All three components widen proportionally to the volatility increase.
- Only the inventory component widens; adverse-selection and order-processing are volatility-independent.
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