Market participants commonly see the bid-ask spread widen in the minutes before major economic announcements. This is a predictable reaction as liquidity providers and traders adjust to the possibility of sudden information arrival and rapid price movements. Evidence from market microstructure research explains why spreads behave this way and what it means for market functioning.
Causes
One central cause is adverse selection: market makers fear trading with better-informed counterparties just before announcements. Maureen O'Hara Cornell University explains that when information asymmetry rises, dealers protect themselves by increasing spreads. A related mechanism is inventory risk. Paul Milgrom Stanford University shows that dealers widen spreads to manage the risk of holding positions that could move sharply once new information is revealed. Another influential model by Albert S. Kyle Massachusetts Institute of Technology describes how the potential for informed trading increases price impact and reduces the willingness of liquidity providers to quote tight prices. Volatility expectations around announcements also amplify these effects because higher expected price variance raises the cost of providing immediacy.
Relevance and consequences
Widening spreads reduce immediate liquidity, meaning traders face higher explicit transaction costs and delayed execution. For institutional traders this can increase implementation shortfall; for retail investors it can make apparently liquid markets expensive to access. Policymakers at central banks such as the Federal Reserve and the European Central Bank influence the pattern and magnitude of these effects through the timing and transparency of their communication. Markets with thin depth or fragmented venues, common in smaller or emerging economies, typically experience larger and longer-lasting spread increases, reflecting territorial and infrastructural constraints.
Human factors also matter: dealer risk tolerance, competition among liquidity providers, and cultural differences in market-making practices shape how quickly spreads normalize after announcements. Environmental considerations such as concentrated trading in specific time zones can produce predictable windows of low liquidity globally. In sum, spread widening before major announcements is a rational response to information and risk, with tangible consequences for price discovery, trading costs, and market access that vary by market structure and institutional context.