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The impact of reduced pre-trade transparency regimes on market quality

Listed author(s):
  • Kovaleva, Polina
  • Iori, Giulia

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 reveals 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.

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File URL: http://www.sciencedirect.com/science/article/pii/S0165188915000913
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Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 57 (2015)
Issue (Month): C ()
Pages: 145-162

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Handle: RePEc:eee:dyncon:v:57:y:2015:i:c:p:145-162
DOI: 10.1016/j.jedc.2015.05.011
Contact details of provider: Web page: http://www.elsevier.com/locate/jedc

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  1. Thierry Foucault, 1999. "Order flow composition and trading costs in a dynamic limit order market," Post-Print hal-00459769, HAL.
  2. Chiarella, Carl & Iori, Giulia, 2009. "The impact of heterogeneous trading rules on the limit order book and order flows," Journal of Economic Dynamics and Control, Elsevier, vol. 33(3), pages 525-537.
  3. Tarun Chordia, 2001. "Market Liquidity and Trading Activity," Journal of Finance, American Finance Association, vol. 56(2), pages 501-530, 04.
  4. Frey, Stefan & Sandås, Patrik, 2009. "The impact of iceberg orders in limit order books," CFR Working Papers 09-06, University of Cologne, Centre for Financial Research (CFR).
  5. Garry F. Barrett & Stephen G. Donald, 2003. "Consistent Tests for Stochastic Dominance," Econometrica, Econometric Society, vol. 71(1), pages 71-104, January.
  6. Buti, Sabrina & Rindi, Barbara, 2013. "Undisclosed orders and optimal submission strategies in a limit order market," Journal of Financial Economics, Elsevier, vol. 109(3), pages 797-812.
  7. Angel Pardo & Roberto Pascual, 2012. "On the hidden side of liquidity," The European Journal of Finance, Taylor & Francis Journals, vol. 18(10), pages 949-967, November.
  8. Copeland, Thomas E & Galai, Dan, 1983. " Information Effects on the Bid-Ask Spread," Journal of Finance, American Finance Association, vol. 38(5), pages 1457-1469, December.
  9. Anand, Amber & Weaver, Daniel G., 2004. "Can order exposure be mandated?," Journal of Financial Markets, Elsevier, vol. 7(4), pages 405-426, October.
  10. Rudy De Winne & Catherine D'hondt, 2007. "Hide-and-Seek in the Market: Placing and Detecting Hidden Orders," Review of Finance, European Finance Association, vol. 11(4), pages 663-692.
  11. Flood, Mark D, et al, 1999. "Quote Disclosure and Price Discovery in Multiple-Dealer Financial Markets," Review of Financial Studies, Society for Financial Studies, vol. 12(1), pages 37-59.
  12. Madhavan, Ananth & Porter, David & Weaver, Daniel, 2005. "Should securities markets be transparent?," Journal of Financial Markets, Elsevier, vol. 8(3), pages 265-287, August.
  13. Seppi, Duane J, 1997. "Liquidity Provision with Limit Orders and a Strategic Specialist," Review of Financial Studies, Society for Financial Studies, vol. 10(1), pages 103-150.
  14. Bloomfield, Robert & O'Hara, Maureen, 1999. "Market Transparency: Who Wins and Who Loses?," Review of Financial Studies, Society for Financial Studies, vol. 12(1), pages 5-35.
  15. Ranaldo, Angelo, 2004. "Order aggressiveness in limit order book markets," Journal of Financial Markets, Elsevier, vol. 7(1), pages 53-74, January.
  16. Yamamoto, Ryuichi, 2011. "Order aggressiveness, pre-trade transparency, and long memory in an order-driven market," Journal of Economic Dynamics and Control, Elsevier, vol. 35(11), pages 1938-1963.
  17. Ingrid Lo & Stephen G. Sapp, 2005. "Order Submission: The Choice between Limit and Market Orders," Staff Working Papers 05-42, Bank of Canada.
  18. Foucault, Thierry, 1999. "Order flow composition and trading costs in a dynamic limit order market1," Journal of Financial Markets, Elsevier, vol. 2(2), pages 99-134, May.
  19. Shmuel Baruch, 2005. "Who Benefits from an Open Limit-Order Book?," The Journal of Business, University of Chicago Press, vol. 78(4), pages 1267-1306, July.
  20. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-1335, November.
  21. Aitken, Michael J. & Berkman, Henk & Mak, Derek, 2001. "The use of undisclosed limit orders on the Australian Stock Exchange," Journal of Banking & Finance, Elsevier, vol. 25(8), pages 1589-1603, August.
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