The Relationship between Liquidity and Transparency: A Minimum of Opaqueness for a Sufficient Market Liquidity
(2002) 29th European Finance Association (EFA) Annual Meeting - Doctoral Seminar — Location: Berlin, Allemagne
Files
No attached file found for this publication.
Details
- Authors
- Abstract
- (en) Liquidity and transparency are nowadays key factors in competition between financial markets. Market liquidity means the ability for traders to buy or sell any amount of stocks immediately at a price very close to the current market price. Market transparency can be defined as the ability for traders to observe information about the trading process. Pretrade (Quote) transparency refers to the dissemination of the limit order book content. Posttrade (Trade) transparency refers to the public transmission of information on past trades. Today diffusion of information is improved by an increasing automation of the trading systems. However, the market transparency level lies at the heart of controversial debates. At first sight, a totally transparent structure would lead to a greater popularization of information. Indirectly, market liquidity and price e±ciency would be enhanced. However, no financial market appears to be fully transparent. Inversely, a lot of markets tend to maintain a certain opaqueness. The most often implemented means are the trades delayed reporting in quote-driven markets and the hidden orders in order-driven markets. In order-driven markets, orders submitted by traders are registered in an electronic limit order book according to their direction (buy or sell), their price (price priority) and their arrival time (time precedence). A trade occurs from the placement of an order satisfying the conditions of another order already in the book. Traders are told liquidity suppliers (demanders) when they submit limit (market) orders on the market. To be successful, orderdriven trading systems have to gather supply and demand of liquidity. Liquidity demanders submit their orders where they expect they will be filled. Hence markets have to expose liquidity offer to attract them. However, liquidity suppliers displaying their willingness to trade expose themselves to various risks. The order exposure risk is straight related to the market transparency level. Actually, some parasitic traders may infer the traders' motives or the securities values from the disclosed order flow (front-running). They also may try to benefit from implicit trading options (quote-matching) [Harris(1997)]. Consequently, in order to incite traders to provide liquidity, order-driven trading systems have to propose facilities that help traders to control their order exposure risk. Most of financial markets permit traders to cancel and modify their orders at any time. Some systems, like NSC on Euronext, also allow them to use hidden orders. Traders submitting hidden orders show other market participants only a part of the total quantity they want to buy or sell. In this context, hidden orders seem to be a real trade-off between liquidity and transparency. They voluntarily allow markets to maintain opaqueness in order to avoid a flight of liquidity supply towards less transparent trading systems. Therefore, a lot of specific features are to be investigated beyond hidden order use, for both the market and the traders.
- Affiliations
Louvain School of Management Accounting & Finance
Citations
D’Hondt, C. (2002). The Relationship between Liquidity and Transparency: A Minimum of Opaqueness for a Sufficient Market Liquidity. 29th European Finance Association (EFA) Annual Meeting - Doctoral Seminar, Berlin, Allemagne. https://hdl.handle.net/2078.5/71086