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Anonymity, Adverse Selection, and the Sorting of Interdealer Trades

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  • Peter C. Reiss

Abstract

This article uses unique data from the London Stock Exchange to examine how trader anonymity and market liquidity affect dealers' decisions about where to place interdealer trades. During our sample period, dealers could trade with each other in the direct, nonanonymous public market or use one of four anonymous brokered trading systems. Surprisingly, we find that adverse selection is less prevalent in the anonymous brokered markets. We show that this pattern can be explained by the way dealers "price" the adverse selection risk inherent in trading with other dealers. We also relate our findings to recent changes in dealer markets. Copyright 2005, Oxford University Press.

Suggested Citation

  • Peter C. Reiss, 2005. "Anonymity, Adverse Selection, and the Sorting of Interdealer Trades," Review of Financial Studies, Society for Financial Studies, vol. 18(2), pages 599-636.
  • Handle: RePEc:oup:rfinst:v:18:y:2005:i:2:p:599-636
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    File URL: http://hdl.handle.net/10.1093/rfs/hhi005
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    Cited by:

    1. Angelidis, Timotheos & Andrikopoulos, Andreas, 2010. "Idiosyncratic risk, returns and liquidity in the London Stock Exchange: A spillover approach," International Review of Financial Analysis, Elsevier, vol. 19(3), pages 214-221, June.
    2. Ligon, James A. & Liu, Hao-Chen, 2013. "The relation of trade size and price contribution in a traditional foreign exchange brokered market," Pacific-Basin Finance Journal, Elsevier, pages 1024-1045.
    3. Goldstein, Michael A. & Shkilko, Andriy V. & Van Ness, Bonnie F. & Van Ness, Robert A., 2008. "Competition in the market for NASDAQ securities," Journal of Financial Markets, Elsevier, vol. 11(2), pages 113-143, May.
    4. Marco Di Maggio & Marco Pagano, 2012. "Financial Disclosure and Market Transparency with Costly Information Processing," EIEF Working Papers Series 1212, Einaudi Institute for Economics and Finance (EIEF), revised May 2014.
    5. Comerton-Forde, Carole & Tang, Kar Mei, 2009. "Anonymity, liquidity and fragmentation," Journal of Financial Markets, Elsevier, vol. 12(3), pages 337-367, August.
    6. Hörner, Johannes & Lovo, Stefano, 2017. "Belief-free Price Formation," TSE Working Papers 17-790, Toulouse School of Economics (TSE).
    7. Berkman, Henk & Koch, Paul D., 2008. "Noise trading and the price formation process," Journal of Empirical Finance, Elsevier, pages 232-250.
    8. Cantillon, Estelle & Yin, Pai-Ling, 2008. "Competition between Exchanges: Lessons from the Battle of the Bund," CEPR Discussion Papers 6923, C.E.P.R. Discussion Papers.
    9. Valseth, Siri, 2016. "Informed trading in Hybrid Bond Markets," UiS Working Papers in Economics and Finance 2016/13, University of Stavanger.

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