Market transparency
Market transparency
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What is market transparency?
▶ Transparency refers to the ability of market participants to
observe information about the trading process.
▶ Pre-trade transparency and Post-trade transparency
▶ Pre-trade transparency: Displays of prices, quotes, volumes,
limit order book, order flow info. Identities of market
participants.
▶ Post-trade transparency: Displays of transaction prices and
trade sizes
Market transparency
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Why is it important?
▶ The data that markets release to the public is extremely
valuable.
▶ Transparency is good because
▶ allow better price discovery for (uninformed) trader and
enhance market efficiency.
▶ lower the cost to uninformed traders (Forster & George, 1992).
▶ it helps customers to monitor brokers (reduce the likelihood of
front-running).
▶ it enhances competition.
▶ it discourages insiders from exploiting uninformed traders
(Chowdhry & Nanda, 1991).
Market transparency
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Why is it important?
▶ Transparency is bad because
▶ Transparency may reduce the incentive to place limit orders
because of the free option value (Porter & Weaver, 1998).
▶ Transparency may be easier for informed traders to pick off
free options that are in-the-money.
▶ Transparency may reveal (informed) trader’s identity causing
them to lose informational advantage and also affect MM’s
welfare (Bloomfield & O’Hara, 1999)
▶ Transparency may exacerbate price volatility (Madhavan,
1996) as it reduces the amount of “noise” in the market.
Market transparency
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Optimal level of transparency
▶ Transparency affects investors’ tactic decisions. How do you
time your orders? What should be the size of your orders? At
which prices would you be willing to trade? In which market
do you want to trade?
▶ What is the optimal level of transparency?
▶ Hard to find as it is difficult to satisfy everyone since changes
in transparency benefit one group at the expense of the other
group
Market transparency
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Market transparency in some U.S. and International
Markets (Harris (2003))
Market transparency
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What about Australia?
▶ The ASX is one of the most transparent market in the world.
▶ It offers limit order traders the option to not reveal the
quantity of an order with a value in excess of $200,000.
▶ Broker ID information was available to all traders until Nov 28,
2005.
▶ ASX argued that Broker ID information potentially invite
market manipulation, increases volatility, distorts pricing and
ultimately reduces liquidity
▶ Comerton-Forde and Tang (2009) show that the removing of
broker ID reduces spreads and order aggressiveness, with
increases in order book depth, which is suggestive of limit
order traders being more inclined to expose their orders when
they can do so anonymously.
▶ All crossing system (dark) trades must be reported to the
ASIC (though this information are not made public).
Market transparency
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Exceptions to the pre-trade transparency requirements
▶ ASIC market integrity rules: Exceptions to the pre-trade
transparency requirements:
▶ block trades
▶ large portfolio trades
▶ trades with price improvement
▶ permitted trades during the post-trading hours period
▶ permitted trades during the pre-trading hours period and
▶ out of hours trades.
▶ Traders are not required to submit the above orders to the
pre-trade transparent order book.
▶ Why?
Market transparency
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Hidden orders
▶ Some exchanges allow participants to hide a large portion of
their order size and signal their interest in trading to the
market.
▶ Aitken, Berkman and Mak (2001) show how the use of
undisclosed limit orders reduce option value of limit orders.
They also show that increase in pre-trade transparency lowers
trading volume!
▶ Iceberg orders: use to hide the actual order quantity
Market transparency
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Hidden orders
▶ On the ASX, iceberg orders are allowed. But the minimum
limit on the shown quantity is 5,000 shares and no maximum
limit.
▶ When the entire shown quantity is traded, the order is
immediately replenished in the order book as the last order at
its price.
▶ Study by Allen, Cheng, Comerton-Forde and Wang (2007)
show that iceberg orders improve liquidity (spread shrinks!)
and traders behind these orders have no additional
information content.
▶ While Frey and Sandas (2009) show that there is positive
liquidity externality, it also creates an adverse selection cost!
▶ Bessembinder, Panayides and Venkataraman (2009) study
relative costs and benefits of order exposure and find that
hidden orders are associated with lower implementation
shortfall cost and smaller opportunity cost; but takes longer to
execute, i.e. higher non-execution risk
Market transparency
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Dark pools
▶ More interesting question: How does the emergence of dark
pools (low market transparency) affect trading outcomes?
▶ Market fragmentation
▶ We will cover this important topic in Week 12
Market transparency
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