{
  "id": "0ef6d82c-807d-551f-a0cd-739105ab5062",
  "slug": "bid-ask-spread",
  "term": "Bid-Ask Spread",
  "aliases": [],
  "category": "Market Microstructure",
  "category_slug": "market-microstructure",
  "difficulty": "basic",
  "definition": "The bid-ask spread is the difference between the highest price a buyer is willing to pay for an asset (the bid) and the lowest price a seller is willing to accept (the ask or offer) at a given moment, representing the immediate transaction cost of trading the asset and a primary component of total execution cost for market participants.",
  "key_takeaways": [
    "The bid-ask spread is the market maker's compensation for providing liquidity, bearing inventory risk, and managing adverse selection from informed traders.",
    "Spreads are narrowest for highly liquid, frequently traded assets (large-cap equities, on-the-run Treasuries) and widest for illiquid, infrequently traded assets (small-cap equities, high-yield bonds, OTC derivatives).",
    "The effective spread — the realized cost of a round-trip transaction — can differ from the quoted spread due to price improvement or internalization.",
    "Quoted spread = Ask − Bid; Relative spread = (Ask − Bid) / Midpoint × 100%; Effective spread = 2 × |Execution Price − Midpoint|.",
    "Spread decomposition models allocate the spread between order processing costs, inventory holding costs, and adverse selection costs (the premium charged to offset trading against informed investors)."
  ],
  "detailed_explanation": "The bid-ask spread is the most visible measure of market liquidity and transaction costs. In a two-sided quote, a market maker simultaneously commits to buy at the bid and sell at the ask, earning the spread as compensation for intermediation risk. The economics of market making require that the spread cover three cost components: (1) order processing costs — the administrative and technological costs of posting quotes and executing trades; (2) inventory carrying costs — the cost of holding a position between buying and selling, including financing cost and price risk; and (3) adverse selection costs — the losses incurred when trading with informed investors who know the 'true' value of the security better than the market maker.\n\nThe Glosten-Milgrom (1985) model formalizes adverse selection: if a fraction π of traders are informed, the market maker must widen the spread to break even in expectation. As π increases (more informed trading), spreads widen. This is why spreads widen around earnings announcements, corporate actions, and macroeconomic data releases — the probability of informed trading increases dramatically, forcing market makers to demand more compensation for providing liquidity.\n\nFor practitioners, spread costs are a key component of transaction cost analysis (TCA). A stock with a quoted spread of 1 cent on a $50 stock has a relative spread of 0.02% — effectively negligible for long-only institutional investors who turn their portfolio once per year. The same spread costs 0.02% per one-way trade — or 10% annualized execution cost — for a high-frequency trader executing 500 round-trip trades per day. This asymmetry explains why spreads are of paramount concern for high-turnover quantitative strategies but are secondary to market impact for large-block institutional trades.\n\nIn fixed income and OTC markets, bid-ask spreads are dealer-set and negotiated bilaterally rather than determined by an electronic order book. Investment-grade corporate bond spreads typically range from 0.10–0.50% of price (10–50bps), while high-yield bond spreads can be 0.50–2.00%. In the most illiquid segments of the market — distressed bonds, off-the-run structured products, and exotic OTC derivatives — the spread can be 3–10% or more of price, dramatically affecting the economics of entering and exiting positions.",
  "example": "Apple shares are quoted at bid $174.95 / ask $175.05, a $0.10 absolute spread and a relative spread of 0.057% ($0.10 / $175.00 midpoint). An investor buying $1 million of AAPL at the ask ($175.05) immediately sells at the bid ($174.95) — a round-trip cost of $572 on the trade, or 0.057% — plus commissions. By contrast, a high-yield bond is quoted by a dealer at bid $94.00 / ask $96.00 — a $2 absolute spread on a $100 face value bond, or 2.1% relative spread. An investor buying $10 million face value of that bond at $96 would need the bond's price to rise by more than 2.1% just to break even on a round-trip transaction — a significant barrier to trading that strongly favors longer holding periods.",
  "formula": "Quoted Spread = Ask - Bid\nRelative Spread = (Ask - Bid) / Midpoint\nEffective Spread = 2 × |Trade Price - Midpoint at Time of Trade|",
  "formula_latex": null,
  "interactive_type": "calculator",
  "calculator_id": null,
  "related_terms": [
    "accommodation-trading",
    "bond",
    "corporate-bond",
    "cover",
    "dutch-auction",
    "face-value",
    "high-yield-bond",
    "immediate-or-cancel-order",
    "liquidity",
    "market-impact",
    "market-maker",
    "market-order",
    "order-book",
    "price-banding",
    "stock"
  ],
  "backlinks": [
    "agency-execution",
    "anonymous-bidding",
    "arrival-price-algorithm",
    "at-the-money",
    "backtesting-framework",
    "bear-spread",
    "book-transfer",
    "broker-dealer",
    "central-limit-order-book",
    "cholesky-decomposition",
    "co-location",
    "crossing-network",
    "crypto-derivatives",
    "dark-liquidity",
    "exchange",
    "explicit-transaction-costs",
    "floor-trader",
    "futures-contract",
    "high-frequency-trading",
    "implicit-transaction-costs",
    "internalization",
    "job-lot",
    "latency",
    "layering",
    "leverage-risk",
    "limit-order",
    "liquidity",
    "liquidity-risk",
    "local-floor-trader",
    "machine-learning-in-finance",
    "many-to-many-trading",
    "market-depth",
    "market-maker",
    "municipal-bond",
    "natural-liquidity",
    "options-chain",
    "order-book",
    "over-the-counter-market",
    "payment-for-order-flow",
    "pegged-order",
    "principal-trading",
    "put-call-parity",
    "quote-stuffing",
    "reinforcement-learning",
    "repurchase-agreement",
    "risk-trading",
    "round-turn",
    "scalper",
    "slippage",
    "synthetic-forward",
    "tick-size",
    "transaction-cost-analysis",
    "twap-order",
    "variable-price-limit",
    "vwap-algorithm",
    "writer-option"
  ],
  "cross_references": [
    "bond",
    "corporate-bond",
    "cover",
    "face-value",
    "high-yield-bond",
    "liquidity",
    "market-impact",
    "market-maker",
    "order-book",
    "stock",
    "transaction-cost-analysis",
    "yield"
  ],
  "tags": [
    "level:basic",
    "cat:market-microstructure"
  ],
  "asset_classes": [],
  "regulators": [],
  "see_also": [],
  "sources": [
    "glosten-milgrom-1985"
  ],
  "wordcount": 689,
  "checksum": "4f96a36b7dfc8e6d",
  "version": "2026.05.03",
  "license": "CC-BY-4.0",
  "updated_at": "2026-09-07T02:15:24+00:00",
  "_links": {
    "self": "https://hedgefund.wiki/api/v1/terms/bid-ask-spread",
    "jsonld": "https://hedgefund.wiki/api/v1/terms/bid-ask-spread?format=jsonld",
    "markdown": "https://hedgefund.wiki/api/v1/terms/bid-ask-spread?format=md",
    "graph": "https://hedgefund.wiki/api/v1/graph/bid-ask-spread",
    "category": "https://hedgefund.wiki/api/v1/categories/market-microstructure",
    "schema": "https://hedgefund.wiki/schema/term.schema.json",
    "html": "https://hedgefund.wiki/#/terms/bid-ask-spread"
  }
}