The paper by Cohen, Maier, Schwartz, and Whitcomb (CMSW) presents the authors' comments on previous literature about bid-ask spreads in securities markets and the way in which they are formed and also gives a number of the authors' own ideas on the topic. I have a few comments on what they have to say in both of these categories, but I will emphasize the latter, since I find it more interesting to comment on their own assertions than to comment on their comments about others. In this and previous versions of their paper and previous papers on the same topic, CMSW have explained that they view price movements over time in securities markets as being partly the result of underlying economic changes and partly a reflection of the impact of idiosyncratic orders that come in from individual investors. On the latter point, I do not find their view very convincing. Individuals decide to trade a security, I believe, for essentially one of two reasons: a desire to change their cash balances or a result of a change in probability beliefs about future returns. I do not believe that either of these situations will result in an impact on security price unless they influence to action at the same time large numbers of investors, in which case they represent exactly the source of underlying economic changes which ought to affect price.

The widespread notion that dollar-cost averaging can help an investor minimize the risk of investing all of one's capital in the market at an inappropriate time is aptly stated by Malkiel [4, p. 242]:

Periodic investments of equal dollar amounts in common stocks can substantially reduce (but not avoid) the risks of equity investment by insuring that the entire portfolio of stocks will not be purchased at temporarily inflated prices. The investor who makes equal dollar investments will buy fewer shares when prices are high and more shares when prices are low.

One of the interesting anomalies of asset trading in secondary markets is that it is not usually possible to observe actual market clearing prices. Rather, we can only observe transactions as bid and ask price? and infer that the market equilibrium price lies between them. Professor Smidt analyzes continuous transactions data for individual NYSE listed securities during 1977. From it he deduces (1) the behavior of transaction prices, (2) the average size of bid-ask spreads, and (3) the movement of market prices. Given that neither the bid-ask spread nor the actual equilibrium price is observable from the available data, this is an ambitious undertaking. The problem is further complicated by the fact that the transactions data contain three distinct types of trading activity: matching trades at the opening or reopening of the auction market, auction trades (the bulk of activity by number of transactions), and block trades (the second largest activity by dollar volume).

Hedgers are an integral element of most models of futures markets. They are typically viewed as involved in the storage or production process and attempting by futures market transactions to avoid price risk associated with holdings of the underlying commodity. Speculators accept the risk and receive compensation whose size is in considerable dispute. (Keynes [16], Telser [24], Cootner [6], Dusak [8]). This “insurance” view of hedging is sometimes expanded to allow for “discretionary” or “selective” hedging which tends to arise when expectations differ across individuals. Narrow models of hedging in the commodities market (Johnson [14], Heifner [11], Peck [19]), in the foreign exchange market (Ethier [9]), and in the bank loan market (Pyle [20]) as well as more general models of the determination of spot and futures prices that incorporate hedging (Stein [22]) have preceded or ignored the theory of equilibrium asset prices (Sharpe [21], Lintner [17]). On the other hand, recent models of the valuation of futures contrasts in capital market equilibrium have not considered the role of hedgers (Grauer and Litzenberger [10]).

During the explosive growth in options markets, from 18.1 million contracts traded in 1975 to 57.2 million in 1978, institutional participation has lagged. While precise measures are not available, informed estimates suggest that only 12 to 15 percent represents true institutional activity in spite of the fact that one by one, tax, regulatory, and conceptual barriers have been reduced or eliminated. In addition to such retarding factors as lethargy, prejudice, and unfamiliarity, there are still some fundamental characteristics of options which make questionable the prudence of their use by fiduciaries or asset managers in a fiduciary position.