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When observing bid/offer in the market I came across a question.

How much trading a bond would impact its spread for subsequent trades ie. what is the impact on bid/offer due to volume/size of recently palced trades.

The size of trades placed in market with impact the liquidity , demand supply , market sentiment etc. I know it is hard to predict how much the spreads will move after a trade /trades of specific size are placed in market. But is there is reasonble assumption that practitioners make ? Any pointers on existing research will be great too .

EDIT : This is indeed a very hard thing to compute. This is not an extensive list of explanatory variables but one can say that –

  1. Spreads will be inversely related to the market maker's ability to hedge his positions
  2. Spreads will be directly related to volatility of the security
  3. Spreads will be directly related size and frequency of quotes from Market makers. Some aggregation using ALL QUOTES of Bloomberg should help us estimate this.

I believe that we can model such a behaviour by

a. Either perturbation based approach such as http://www.maths.univ-evry.fr/prepubli/342.pdf

b. Compound Autoregressive possion’s process.

If I have something worked out , I will share the results. In the meantime if you have methodology that you use as a practitioner please do share .

Thanks

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You should turn to market microstructure research. Large and frequent trades can temporarily increase the spread and observed transaction price. Additionaly, trades done near the release of new information ( macro news, firms news,...) most likely need to overcome larger spreads.

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  • $\begingroup$ Sorry but I dont know what you mean by "market microstructure research" . Also edited the question to demostrate that the question is not asking "if there will be effect" in spreads due to large volume trade or announcement effect but "What" will be approx change. $\endgroup$ – ash Feb 2 '15 at 18:48
  • $\begingroup$ I agree with @QuantK that you should refer to mkt microstructure literature. I'm no expert, but my impression is that large orders tend not to have substantial impact on bid/ask spreads. However, the "market impact" can be substantial and that's where a lot of research has been happening. You can find a very rich set of literature on market impact estimation (aka transaction cost models), but it boils down to transient impact caused by supply/demand imbalance, and permanent impact caused by changes in perceived fair value. $\endgroup$ – Helin Mar 4 '15 at 22:57
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If you are after treasuries, you can check

http://www.newyorkfed.org/research/staff_reports/sr381.pdf

which discusses trade impact on BrokerTec. If you are after equities, the literature is enormous, you can pretty much google for "trade impact limit order book" or smth similar. In practice, it's an empirical approach: you put all the factors, that seem important, run regression or some ML algo on it, and pick the factors, that have most explanatory power.

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