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%T Relation between Bid-Ask Spread, Impact and Volatility in Order-Driven Markets %A Bouchaud, Jean-Philippe %A Vettorazzo, Michele %A Kockelkoren, Julien %A Wyart, Matthieu %A Potters, M %J Quantitative Finance %N 1 %P 41-57 %V 8 %D 2007 %K Microstructure; Bid-ask spread; Impact; Liquidity %= 2011-03-15T13:28:00Z %~ http://www.peerproject.eu/ %> https://nbn-resolving.org/urn:nbn:de:0168-ssoar-221056 %X We show that the cost of market orders and the profit of infinitesimal market-making or -taking strategies can be expressed in terms of directly observable quantities, namely the spread and the lag-dependent impact function. Imposing that any market taking or liquidity providing strategies is at best marginally profitable, we obtain a linear relation between the bid-ask spread and the instantaneous impact of market orders, in good agreement with our empirical observations on electronic markets. We then use this relation to justify a strong, and hitherto unnoticed, empirical correlation between the spread and the volatility per trade, with R2s exceeding 0.9. This correlation suggests both that the main determinant of the bid-ask spread is adverse selection, and that most of the volatility comes from trade impact. We argue that the role of the time-horizon appearing in the definition of costs is crucial and that long-range correlations in the order flow, overlooked in previous studies, must be carefully factored in. We find that the spread is significantly larger on the NYSE, a liquid market with specialists, where monopoly rents appear to be present. %C GBR %G en %9 journal article %W GESIS - http://www.gesis.org %~ SSOAR - http://www.ssoar.info