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Trader Anonymity, Price Formation and Liquidity

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  • Erik Theissen

Abstract

Using data from the Frankfurt Stock Exchange we analyze price formation and liquidity in a non-anonymous environment with similarities to the floor of the NYSE. Our main hypothesis is that the non-anonymity allows the specialist to assess the probability that a trader trades on the basis of private information. He uses this knowledge to price discriminate. This can be achieved by quoting a large spread and granting price improvement to traders deemed uninformed. Consistent with our hypothesis we find that price improvement reflects lower adverse selection costs but does not lead to a reduction in the specialist's profit. Further, the quote adjustment following transactions at the quoted bid or ask price is more pronounced than the quote adjustment after transactions at prices inside the spread. Our results indicate that anonymity comes at the cost of higher adverse selection risk.

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Bibliographic Info

Paper provided by University of Bonn, Germany in its series Bonn Econ Discussion Papers with number bgse20_2002.

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Length: 43
Date of creation: Aug 2002
Date of revision:
Handle: RePEc:bon:bonedp:bgse20_2002

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Postal: Bonn Graduate School of Economics, University of Bonn, Adenauerallee 24 - 26, 53113 Bonn, Germany
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Web page: http://www.bgse.uni-bonn.de

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Keywords: anonymity; bid-ask spreads; floor trading; price improvement; specialists;

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References

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Citations

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Cited by:
  1. Louis R. Mercorelli & David Michayluk & Anthony D. Hall, 2008. "Modelling Adverse Selection on Electronic Order-Driven Markets," Research Paper Series 220, Quantitative Finance Research Centre, University of Technology, Sydney.
  2. Tarun Ramadorai, 2008. "What determines transaction costs in foreign exchange markets?," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 13(1), pages 14-25.
  3. Dirk Schiereck & Christian Voigt, 2010. "With or without you: market quality of floor trading when screen trading closes early," Review of Quantitative Finance and Accounting, Springer, vol. 34(2), pages 179-197, February.
  4. Foucault, Thierry & Moinas, Sophie & Theissen, Erik, 2003. "Does Anonymity Matter in Electronic Limit Order Markets?," CEPR Discussion Papers 4091, C.E.P.R. Discussion Papers.
  5. G. Desgranges & T. Foucault, 2001. "Price Improvements in Financial Markets as a Screening Device," THEMA Working Papers 2001-06, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise.
  6. Richie, Nivine & Madura, Jeff, 2007. "Impact of the QQQ on liquidity and risk of the underlying stocks," The Quarterly Review of Economics and Finance, Elsevier, vol. 47(3), pages 411-421, July.
  7. Comerton-Forde, Carole & Rydge, James, 2006. "The current state of Asia-Pacific stock exchanges: A critical review of market design," Pacific-Basin Finance Journal, Elsevier, vol. 14(1), pages 1-32, January.
  8. Desgranges, Gabriel & Foucault, Thierry, 2005. "Reputation-based pricing and price improvements," Journal of Economics and Business, Elsevier, vol. 57(6), pages 493-527.
  9. Osler, Carol & Mende, Alexander & Menkhoff, Lukas, 2006. "Price Discovery in Currency Markets," Hannover Economic Papers (HEP) dp-351, Leibniz Universität Hannover, Wirtschaftswissenschaftliche Fakultät.
  10. Grammig, Joachim & Schiereck, Dirk & Theissen, Erik, 2001. "Knowing me, knowing you: : Trader anonymity and informed trading in parallel markets," Journal of Financial Markets, Elsevier, vol. 4(4), pages 385-412, October.
  11. Alexandra Hachmeister & Dirk Schiereck, 2010. "Dancing in the dark: post-trade anonymity, liquidity and informed trading," Review of Quantitative Finance and Accounting, Springer, vol. 34(2), pages 145-177, February.
  12. Sabrina Buti & Barbara Rindi & Ingrid M. Werner, 2011. "Dark Pool Trading Strategies," Working Papers 421, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  13. Ramadorai, Tarun, 2006. "Persistence, Performance and Prices in Foreign Exchange Markets," CEPR Discussion Papers 5861, C.E.P.R. Discussion Papers.

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