Covid-19 implications on the Bid-Ask spread in the FX market
The Bid-ask spread can be defined as the asking price minus the bid price (Krinsky,1996). The spread is often interpreted as the commission the bank asks for exchanging currencies. Factors that contribute to the level of spread is the liquidity/ number of shares traded daily, as largely traded items will have a lower spread as they are liquid. However, items infrequently traded will require a larger spread to pay broker fees. Additionally, it can change due to the stock price, for example, if a new/small company trades its stocks it may have a large spread due to limited stocks making them less liquid.
Another key aspect that influences the bid-ask spread is volatility. This can be closely related to the coronavirus as this is uncertainty and has declined the market. Figure 1 shows the FTSE 100 and the effect of the coronavirus proving to be unstable. Thus, causing the spread to increase due to the uncertainty of the future. According to Bloomberg, (2020) when liquidity reduces in the market and an increase in volatility causes the spread to increase. The effect of the coronavirus may last for many years to come having the potential to cause the next financial crash.
Ultimately, the bid-ask spread comes down to supply and demand. That is, higher demand and tighter supply will mean a lower spread. Today, with the help of technology, finding a buyer or seller can be done much quicker, helping make supply-and-demand dynamics much more efficient.
