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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. JEL Classification: G10.

Suggested Citation

  • Erik Theissen, 2003. "Trader Anonymity, Price Formation and Liquidity," Review of Finance, European Finance Association, vol. 7(1), pages 1-26.
    • Handle: RePEc:oup:revfin:v:7:y:2003:i:1:p:1-26.
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    File URL: http://hdl.handle.net/10.1023/A:1022579423978
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    Cited by:

    1. He, Yinghua & Nielsson, Ulf & Guo, Hong & Yang, Jiong, 2014. "Subscribing to transparency," Journal of Banking & Finance, Elsevier, vol. 44(C), pages 189-206.
    2. Paiardini, Paola, 2015. "Informed trading in parallel bond markets," Journal of Financial Markets, Elsevier, vol. 26(C), pages 103-121.
    3. Thomas Johann & Erik Theissen, 2013. "Liquidity measures," Chapters,in: Handbook of Research Methods and Applications in Empirical Finance, chapter 10, pages 238-255 Edward Elgar Publishing.
    4. Werner Antweiler, 2017. "Emission trading for air pollution hot spots: getting the permit market right," Environmental Economics and Policy Studies, Springer;Society for Environmental Economics and Policy Studies - SEEPS, vol. 19(1), pages 35-58, January.

    More about this item

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

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