Bid-Ask Spread Modelling in the South African Bond Market

Shaw, Matthew

Bid-Ask Spread Modelling in the South African Bond Market

Master Thesis

2018

Publisher

University of Cape Town

Department

African Institute of Financial Markets and Risk Management

Faculty

Faculty of Commerce

Abstract

Pitsillis and Taylor (2014) calculate bid-ask spread estimates of South African government bonds over a single year, using the models of De Jong and Rindi (2009) and Huang and Stoll (1997). This dissertation tests the effectiveness of both models by comparing the modelled equity spread estimates against the actual equity spread estimates. Furthermore, this dissertation investigates the stability of the De Jong and Rindi (2009) and Huang and Stoll (1997) models in the bond market by extending the spread estimate dataset to run annually over 5 years. The final section of this dissertation proposes a new method of estimating the bond spread through the use of a Kalman filter, as it can be used to leverage information from an onscreen market (albeit a different market) to imply bid-ask spread estimates in an off-screen market. The results indicate that the Huang and Stoll (1997) model consistently outperforms the De Jong and Rindi (2009) model. Furthermore, the yield estimate results of Pitsillis and Taylor (2014) align with the results obtained in this dissertation. The spread estimate results are stable over the 5-year period, indicating a strong provision of liquidity by the Primary Dealers.

Keywords

Mathematical Finance

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