Why Bid-Ask Spreads Do Not Have a Uniform Relationship with Volatility

Summary

The document considers whether bid-ask spreads vary with volatility and argues that there is no single relationship that applies across markets and trading conditions. The answer recommends tailoring a model to the asset, broker or market maker, and the intended use, rather than assuming that one published relationship will generalize.

Foreign exchange provides contrasting examples. Around the end of the New York trading day, activity can become thin and spreads can widen even when volatility is low. During active periods, the pattern may differ; scheduled announcements can coincide with both wider spreads and higher volatility. These examples illustrate that liquidity, market hours, and event-driven activity can affect spreads alongside volatility. The response offers observations rather than a fitted model or systematic evidence, so it does not quantify effects or establish a general causal relationship. Any spread model should be evaluated in the relevant market and time period.

Key ideas

• The relationship between volatility and bid-ask spreads can vary by asset and trading conditions.
• Thin foreign exchange trading near the end of the New York day can coincide with wide spreads and low volatility.
• Announcements may coincide with both wider spreads and increased volatility.
• Market hours, liquidity, and market-maker behavior should inform a spread model.
• The examples are illustrative and do not establish a universal quantitative relationship.

Tags

# Spread and volatility


# Spread and volatility












I look for any references where one consider how bid-ask spread depends on volatility (may be it is more correct to say 'volatility measure'). I would be grateful for any references.

## Answer by stans (score 1)

https://quant.stackexchange.com/a/60718

Whatever is published out there, you are better off developing the model yourself. The model has to be customized to your objectives. Much depends on the asset and the broker / market maker. And still, there is no clear relationship.

For example, for most currencies the period 5 pm - 5:15 pm (EST) is when many brokers "take the rest" and set very high bid-ask spreads. They take the rest because this is the end of NY day and time for very thin trading. "Thin trading" means low volatility. On the other hand, during active hours the relationship is the reverse. Around the announcements we see increased bid-ask spread and increased volatility. Usually, we are talking about 3:30 am, 5 am and 8:30 am (EST).

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