Hank Bessembinder and Kumar Venkataraman
Encyclopedia of Quantitative Finance, Wiley Publication
Publication year: 2010

Bid-ask spreads, which measure trade execution costs, and reflect the price concessions necessary to complete transactions quickly, are important as indicators of market quality and in determining traders’ actual investment results. Execution costs arise because it is costly to provide liquidity, and can be estimated on the basis of comparisons of trade prices with proxies for underlying security value, with the most common proxy being the quote midpoint. Comparisons can be of trade prices to midpoints at or before the time of the trade, as in effective spread measures, or to midpoints after the trade, as in realized spread measures. Recent research indicates that trade execution costs have declined in US markets in recent years, and documents substantial variation in average trading costs across international equity markets.

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