Stoll's Inventory Model of the Spread

Before information-based theories of the bid-ask spread became standard, Hans Stoll offered a simpler explanation: a market maker who buys a stock at the bid is now holding inventory they didn't necessarily want, and that inventory is risky — the price could move against them before they can sell it back out. The spread is the market maker's compensation for accepting that risk, not for having worse information than the traders they deal with.

In Stoll's framework, a dealer charges a spread wide enough to cover the expected cost of carrying an unwanted position: the risk of the price moving adversely, the cost of financing the position, and the cost of eventually laying off the inventory to another counterparty. A more volatile stock, or a dealer already sitting on a large position in one direction, demands a wider spread, because either factor raises the risk of holding inventory.

Worked example

A dealer quotes a two-cent spread on a stable, low-volatility stock. The same dealer, already long a large position in a much more volatile stock after a string of buy orders, widens the spread to eight cents and skews the quote to encourage sells over buys — not because they suddenly know something the market doesn't, but purely to reduce and offload risky inventory they're currently exposed to.