This paper addresses the issue of optimal transparency in a multiple-dealer market. In particular, we examine the question: Would risk-averse dealers prefer ex-ante that signed order flow were observable? We answer this question with the solution to a mechanism design problem. The resulting incentive-efficient mechanism is one in which signed order flow is not observable. Rather, dealers prefer a slower pace of price discovery because it induces additional risk-sharing. Specifically, slower price discovery permits additional trading with customers prior to revelation; this reduces the variance of unavoidable position disturbances, thereby reducing the market making risk inherent in price discovery. We then apply the framework to the spot foreign exchange market in order to understand better the current degree of transparency in that market.
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
4467.
Length: Date of creation: Sep 1993 Date of revision: Handle: RePEc:nbr:nberwo:4467
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Find related papers by JEL classification: G15 - Financial Economics - - General Financial Markets - - - International Financial Markets G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies
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