Why does the bid-ask spread vary over the day?

Abstract

This paper shows that the findings of Chan, Christie and Schultz (Journal of Business, 68, 1995) of no intraday variation in the average bid-ask spread is not general to all competitive markets, and in particular does not apply to the London Stock Exchange during the mandatory quote period. This is important because it revives the possibility of explanations of intraday variation in the bid-ask spread which involve individual market-makers widening their individual spreads for example in response to informed trading, inelastic demand or the need to discover prices at the start of the day. However there is no evidence of individual market makers widening their bid-ask quote spreads during the warm up and cool down periods at the start and the end of the trading day outwith the mandatory quote period. The only single explanation which might explain the whole day variation observed in the inside and the average bid-ask spreads both inside and outside of the mandatory quote is inventory control.