Market Transparency and Fragility

Xavier Vives and Giovanni Cespa

No 11732, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: We show that dealers' limited market participation, coupled with an informational friction resulting from lack of market transparency, can make liquidity demand upward sloping, inducing strategic complementarities: traders demand more liquidity when the market becomes less liquid, fostering market illiquidity. This can generate instability with an initial dearth of liquidity degenerating into a liquidity rout (as in a flash crash). In a fully transparent market, liquidity is increasing in the proportion of dealers continuously present in the market; however, in a less transparent market, liquidity can be U-shaped in this proportion and in the degree of transparency.

Keywords: Market fragmentation; Liquidity fragility; Flash crash; Asymmetric information (search for similar items in EconPapers)
JEL-codes: G10 G12 G14 (search for similar items in EconPapers)
Date: 2016-12
New Economics Papers: this item is included in nep-mst
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Working Paper: Market Transparency and Fragility (2016)
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