easy · Market Microstructure spread-econ
Roll's (1984) serial covariance estimator derives the effective bid-ask spread from the first-order autocovariance of price changes. The formula is S = 2 times sqrt(negative Cov), where Cov is the covariance of consecutive price changes.
If the estimated Cov = negative 0.0025 (in squared dollar terms), what is the Roll-implied effective spread?
- 0.05 dollars, because S = 2 times sqrt(0.0025) = 2 times 0.05 = 0.10 dollars
- 0.10 dollars, because S = 2 times sqrt(0.0025) = 2 times 0.05 = 0.10 dollars
- 0.0025 dollars, because the spread equals the absolute value of the covariance
- 0.005 dollars, because the spread equals sqrt(0.0025) without the factor of 2
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