Security Prices and Market Transparency (Revision of 12-90)

Ananth Madhavan

Rodney L. White Center for Financial Research Working Papers from Wharton School Rodney L. White Center for Financial Research

Abstract: Many recommendations for reforming securities market are predicated on the belief that providing information on order flow and other market variables to traders (i.e., increasing market transparency) will increase liquidity and improve price efficiency. This paper demonstrates that market transparency can actually increase price volatility and lower market liquidity. This occurs even though transparency increases the precision of traders’ predictions about the asset’s value. In a sufficiently large market, transparency always reduces volatility and improves market quality. We use these results to assess policy proposals concerning the disclosure of trading information.

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