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Optimal Transparency in a Dealership Market with an Application to Foreign Exchange

Author

Listed:
  • Richard K. Lyons.

Abstract

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 marketmaking 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.

Suggested Citation

  • Richard K. Lyons., 1993. "Optimal Transparency in a Dealership Market with an Application to Foreign Exchange," Research Program in Finance Working Papers RPF-231, University of California at Berkeley.
    • Handle: RePEc:ucb:calbrf:rpf-231
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    Cited by:

    1. Lyons, Richard K., 1995. "Tests of microstructural hypotheses in the foreign exchange market," Journal of Financial Economics, Elsevier, vol. 39(2-3), pages 321-351.
    2. Nicolas Audet & Toni Gravelle & Jing Yang, 2002. "Alternative Trading Systems: Does One Shoe Fit All?," Staff Working Papers 02-33, Bank of Canada.
    3. Vogler, Karl-Hubert, 1997. "Risk allocation and inter-dealer trading," European Economic Review, Elsevier, vol. 41(8), pages 1615-1634, August.
    4. Victoria Saporta, 1997. "Which Inter-dealer Market Prevails? An analysis of inter-dealer trading in opaque markets," Bank of England working papers 59, Bank of England.
    5. Richard K. Lyons, 1996. "Foreign Exchange Volume: Sound and Fury Signifying Nothing?," NBER Chapters, in: The Microstructure of Foreign Exchange Markets, pages 183-208, National Bureau of Economic Research, Inc.

    More about this item

    JEL classification:

    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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