Liquidity and Optimal Market Transparency

Abstract

In this paper I explore some of the consequences of greater market transparency for market performance in the presence of a strategic specialist. Although numerous studies have dealt with this issue, previous work has only considered either fully transparent or fully opaque markets. My model allows for different levels of transparency, and therefore sheds light on how transparency affects market performance. I show that an intermediate level of transparency can improve market performance relative to the more extreme cases of full transparency or no transparency at all.

Semi‐transparency, dealership market, and foreign exchange market quality

“…These empirical findings support theoretical conclusions that semi‐transparency improves market quality by Lyons (1996) and Dumitrescu (2008), and also are consistent with experimental results obtained in Flood et al (1999). These results also support the claim that greater transparency benefits uninformed dealers at the expense of informed dealers in the decentralized market, as suggested by Duffie et al (2005) and Golosov et al (2008).…”

“…Hence, there is a trade‐off between transparency and market quality, and an optimal quality should occur at some semi‐transparency level. This view has been supported by theoretical papers such as Madhavan (1995), Pagano and Roell (1996), Lyons (1996) and Dumitrescu (2008).…”

“…He finds that traders who demand liquidity are better off when limit order book is open while liquidity suppliers are better off when the book is closed. Similarly, Dumitrescu (2008) suggests that an intermediate level of transparency can improve market performance.…”

What Drives Contagion in Financial Markets? Liquidity Effects versus Information Spill‐Over

“…(FTSE EPRA/NAREIT Global Real Estate Index) 12 return at time t. The market model is estimated using pre-event data for OPF secondary market returns and Real Estate Investment Trust (REIT) returns over a 200-day period from t i,À220 to t i,À20 . Within this approach, we allow for the REITs-adjusted average discounts attributable to new information (approximated by REIT returns) with regard to changes in expected write-off potential (impending NAV impairment) are explicitly incorporated (see Dumitrescu, 2010). This means that the impact of changes in economic conditions over time on expected cash flows is modelled as a channel of contagion explaining the discount rate which is not possible by average abnormal discounts (see Haß et al, 2013 for a reasoning).…”

“…Within this approach, we allow for the REITs‐adjusted average discounts attributable to new information (approximated by REIT returns) with regard to changes in expected write‐off potential ( impending NAV impairment ) are explicitly incorporated (see Dumitrescu, ). This means that the impact of changes in economic conditions over time on expected cash flows is modelled as a channel of contagion explaining the discount rate which is not possible by average abnormal discounts (see Haß et al, for a reasoning).…”