Trading & Markets

Bid-Ask Spread

The difference between the highest price buyers will pay and the lowest sellers will accept.

Compensation for three distinct things, and separating them is what a good answer does: adverse selection from better-informed counterparties, inventory risk while holding a position, and operating costs.

The drivers follow directly. Volatility up raises inventory risk, so spreads widen. More informed traders raises adverse selection, which is why spreads gap out before earnings. Competition compresses spreads toward the cost floor.

The weak interview answer is "market makers buy low and sell high". The strong one names adverse selection as the thing the spread is priced against.

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The Bid-Ask Spread Explained

What the spread compensates a market maker for, why it widens, and what determines its size in practice.

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