Graduation Year

Spring 2014

Document Type

Campus Only Senior Thesis

Degree Name

Bachelor of Arts

Department

Economics

Reader 1

Eric Hughson

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© 2014 Andrew G. Runde

Abstract

This paper will examine the effects of inside information on bid-ask spreads when the probability of insider trading and the likelihood of an informational event occurring varies using a theoretical, simulation-based approach. The results show that bid-ask spreads narrow as the number of time periods increase, regardless of probability of insider trading or the likelihood of an informational event occurring. For a high, given likelihood of an informational event occurring, the highest average spreads were found for lower probabilities of insider trading as time increased. For a high, given probability of insider trading, the highest average spreads were found for lower likelihoods of an informational event occurring as time increased. The variances increased along with the probability of insider trading as well as with the likelihood of an informational event occurring. The maximum average spread settled near 0.25, typically found for a probability of insider trading of 1 and a likelihood of an information event occurring of 0.5. The results verify previous research done by Glosten and Milgrom (1985), Easley, Hvidkjaer and O’Hara (2002) and Potterton (2011). The results also may reconcile the differences between the findings of Easley, Hvidkjaer and O’Hara (2002) and Potterton (2011).

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