We show that bid-ask errors in transaction prices are the predominant source of apparent price reversals in the short run for NASDAQ firms. Once we extract measurement errors in prices caused by the bid-ask spread, we find little evidence of market overreaction. On the contrary, we find that security returns are positively, and not negatively, autocorrelated. We also show that bid-ask errors lead to substantial spurious volatility in transaction returns; about half of measured daily return variances can be induced by the bid-ask effect.

In this paper, we present a simple model which relates security returns to three components: an expected return, a bid-ask error, and white noise. The relative importance of the various components is empirically assessed, and the model's ability to explain the various time-series properties of individual security and portfolio returns is tested. Time-varying expected returns and bid-ask errors are found to explain substantial proportions (up to 24%) of the variance of security returns. We also reconcile the typically negative autocorrelation in security returns with the strong positive autocorrelation in portfolio returns.

We assess the market microstructure properties of U.S. banking firms’ equity, to determine whether they exhibit more or less evidence of asset opaqueness than similar-sized nonbanking firms. The evidence indicates that large bank holding companies (BHC), traded on the NYSE, have very similar trading properties to their matched nonfinancial firms. In contrast, smaller BHCs, traded on NASDAQ, trade much less frequently despite having very similar spreads. Analysis of IBES earnings forecasts indicates that banking assets are not unusually opaque; they are simply boring. The implications for regulatory policy and future market microstructure research are discussed.

Underwriters using bookbuilding can allocate shares of initial public offerings (IPOs) on the basis of, among other things, commissions paid by investors. In testing the hypothesis that investors trade liquid stocks in order to affect their IPO allocations, we find that money left on the table by IPOs is related to the trading volume of the 50 most liquid stocks near the offer date. For an IPO that leaves $1 billion on the table, there is abnormal volume of 2.7% to 4.1% in the 50 most liquid stocks over the six days ending on the day that trading commences in that IPO, although only during the internet bubble period is this volume increase statistically significant.