Pre-Trade Transparency

Ananth Madhavan, David Porter and Daniel Weaver

Istanbul Stock Exchange Review, 2001, vol. 5, issue 17, 23-46

Abstract: A crucial question for security markets concerns the impact on liquidity of public display of investors’ latent demands. This topic is central to on-going debates about floor versus automated trading systems, the informational advantages of market makers, and inter-market competition between trading systems with different levels of transparency. We examinee this topic using transaction-level data from the Toronto Stock Exchange (TSE) before and after the limit order book was publicly disseminated on April 12, 1990. This natural experiment allows us to isolate the effects of transparency while controlling for stock-specific factors and for the type (floor or automated) of trading system. We show that, contrary to popular belief, transparency has detrimental effects on liquidity. In particular, execution costs increased after the introduction of the system even when controlling for other factors that may affect trading costs. We discuss the implications of these results for practitioners.

Date: 2001
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