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Bid-Ask Spread, Quoted Depths, and Unexpected Duration Between Trades

We examine the intraday informational and liquidity effects of unexpected duration between trades on bid-ask spreads and depths. The difference between realized duration and the predicted duration from an autoregressive conditional duration model is used as a proxy for unexpected duration. We find that unexpected short duration alone permanently increases the quoted spread and positively correlates with the adverse-selection component of the effective spread, despite the presence of a liquidity component in the spread adjustment. Unexpected duration for a buyer-initiated trade has a stronger impact on the quoted spread than that for a seller-initiated trade. These results support the implications of information uncertainty in Easley and O’Hara (J Financ 47(2):577–605 1992) and short-sales constraints in Diamond and Verrecchia (J Financ Econ 18:277–311 1987) for the price adjustment behavior. Moreover, we show that unexpected short duration for a seller-initiated (buyer-initiated) trade permanently increases (slightly reduces) the bid (ask) depth and that there is also a liquidity component in the adjustment in depths. We attribute the asymmetric effects on depths to the differential informativeness of buyer- and seller-initiated trades.