Hidden and Displayed Liquidity in Securities Markets with Informed Liquidity Providers (original) (raw)
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SSRN Electronic Journal, 2010
This paper studies a continuous-time stochastic game of trading activity in financial markets under asymmetric information. The model has the following features. First, informed and liquidity traders optimally control the timing of their order submissions. Second, they continuously choose whether to take or provide liquidity, issuing market or limit orders. Third, uninformed traders learn from the order flow optimally exploiting the information in the limit-order book. I construct an equilibrium in this setting and characterize (i) price formation and (ii) how optimal submission intensities and liquidity supply-demand behavior depend on private information and market conditions. I show that all traders types demand and supply liquidity simultaneously, following a distinctive time-varying pattern previously found in experiments. After an information event, inter-arrival times are positively autocorrelated, the price impact of all order types increases and the limit-order book shows depth unbalances. The model nests the cases in which liquidity provision is decentralized (limit-order markets) and centralized (dealer markets). I find that the speed of information transmission into prices is lowered in the decentralized version. Since submission intensities are strategic, the time spacing of the data can be used to learn about traders' optimal policies. I use a unique orderlevel dataset from the NYSE to test structural restrictions on optimal liquidity provision and find support for the model's outcomes. The findings shed light on empirical and experimental results in the literature and have implications for inference methods with high frequency data.
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We empirically investigate the evolution of liquidity, as well as the changing strategies of informed traders, over the course of the trading day. In particular, we empirically examine the relative use of market versus limit orders by informed and liquidity traders early versus later in the trading day using detailed order and audit trail data from the NYSE. Our study complements experimental research that shows that informed traders tend to take liquidity earlier in the trading day while acting as liquidity suppliers later in the day. We find that informed (i.e., institutional) traders actually use market orders more often in the first half of the day than the second. We also find support for informed traders' use of limit orders. Limit orders placed by informed traders perform better than those placed by uninformed ARTICLE IN PRESS www.elsevier.com/locate/finmar 1386-4181/$ -see front matter r (A. Anand).
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We analyze the equilibrium spread when the transaction size of informed traders is elastic in the value of private information (α). We show that the pooling equilibrium is likely to be inefficient when trade size is sensitive to α and the inefficient equilibrium can occur before the market breaks down. The pooling equilibrium spread does not monotonically increase with α, although it increases with the elasticity of informed trades to α. The upper bound of the elasticity of informed trades for the market to remain open for the active specialist is higher than the corresponding value for the passive specialist when the specialist has enough leverage over brokers.
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This paper studies the effects of pre-trade quote transparency on spread, price discovery and liquidity in an artificial limit order market with heterogeneous trading rules. Our agent-based numerical experiments suggest that full quote transparency incurs substantial transaction costs to traders and dampens trading activity in an order-driven market. Our finding reveal that exogenous restriction of displayed depth, up to several best quotes, does not benefit market performance. On the contrary, endogenous restriction of displayed quote depth, by means of iceberg orders, improves market quality in multiple dimensions: it reduces average transaction costs, maintains higher liquidity and moderate volatility, balances the limit order book, and enhances price discovery.
Informed trading and the ‘leakage’ of information
Journal of Economic Theory, 2003
This paper, in a Shapley-Shubik market game framework, examines the effect of "leakage" of information: private information becoming available to uninformed traders at a later date. We show that (a) If information acquisition by the informed traders is costless, this leads to faster revelation of information; (b) If information acquisition is costly, there may be no acquisition of information; (c) Information leakage leads to a fall in value of information and hence, increases the incentive for informed traders to sell the information.
Differential Access to Price Information in Financial Markets
SSRN Electronic Journal, 2000
Recently exchanges have been supplementing their tape revenue by directly selling trade and quote data to some traders. We analyze how this practice affects the cost of capital, market liquidity and welfare by studying a twoperiod economy in which rational traders can purchase information about past transactions from the exchanges. In an economy in which traders are endowed with private signals about asset value, allowing the exchange to sell price data increases the cost of capital and worsens market liquidity relative to a world in which all traders freely observe previous prices. However, selling price data reduces the cost of capital and increases liquidity relative to an economy in which no traders can observe price information. If traders have to decide whether to purchase private signals, as well as whether to purchase price data, selling price data can cause traders to reduce their effort to gather information on the underlying asset. This secondary effect may increase the equilibrium cost of capital, but paradoxically it results in greater liquidity. Our welfare analysis also shows that as more previous price information is present in the market, noise traders are made better-off and speculative rational traders are made worse-off. In our view, allowing exchanges to sell price information is undesirable because it generally reduces efficiency and market quality. We believe that the practice should be restricted.
Prices, Liquidity, and the Information Content of Trades
Review of Financial Studies, 2000
We investigate the effect of asymmetric information on prices and liquidity by analyzing trades, quotes, spreads and depths. Information content should increase with trade size and the degree of information asymmetry of the trading period. Results show that price and liquidity effects are significantly associated with information content as measured by both trade size and the timing of the trade relative to information events. Results are stronger for purchases than sales. Quoted prices are better measures of information effects than transaction prices, because they control for bid-ask bounce. Finally, trades that are known a priori not to contain information have no impact on prices and liquidity, even when they are very large in size.
Liquidity Provider Incentives in Fragmented Securities Markets
SSRN Electronic Journal
We study the introduction of single-market liquidity provider incentives in fragmented securities markets. Specifically, we investigate whether fee rebates for liquidity providers enhance liquidity on the introducing market and thereby increase its competitiveness and market share. Further, we analyze whether single-market liquidity provider incentives increase overall market liquidity available for market participants. Therefore, we measure the specific liquidity contribution of individual markets to the aggregate liquidity in the fragmented market environment. While liquidity and market share of the venue introducing incentives increase, we find no significant effect for turnover and liquidity of the whole market.
2014
This thesis is motivated by the progressive expansion of electronic markets with reduced pre-trade transparency and the collateral liquidity effects. In this thesis I develop three independent theoretical models and explore the repercussions of weak market liquidity and transparency. First, I approach the issue of limited liquidity through the optimal order placement problem of a risk-averse trader in a continuous time context and introduce a random delay parameter, which defers limit order execution and characterises market liquidity. This framework demonstrates that imperfect liquidity explains order clustering in the proximity of best quotes and the existence of the bid-ask spread. The distribution of expected time-to-fill of limit orders conforms to the empirically observed distribution of trading times, and its variance decreases with liquidity. Finally, two additional stylised facts are rationalised in this model: the equilibrium bid-ask spread decreases with liquidity, but in...