Width of a market under uncertainty
You make a market on a quantity whose true value you estimate at 50 with a standard deviation of 4. Should your bid-ask be tight or wide, and why?
Show hints (2)+
- More uncertainty ⇒ more downside from being picked off.
- The spread is your buffer against adverse selection.
Answer
Reveal answer →Final answer
Wide - the spread compensates for the higher uncertainty and adverse-selection risk
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