Risk Aversion, Transparency, and Market Performance
Maria Angeles De Frutos
Universidad Carlos III de Madrid - Department of Economics
Carolina Manzano Tovar
Universitat Rovira i Virgili - Department of Economics
Journal of Finance, Vol. 57, pp. 959-984, 2002
Using a model of market making with inventories based on Biais (1993), we find that investors obtain more favorable execution prices, and they hence invest more, when markets are fragmented. In our model, risk-averse dealers use less aggressive price strategies in more transparent markets (centralized) because quote dissemination alleviates uncertainty about the prices quoted by other dealers and, hence, reduces the need to compete aggressively for order flow. Further, we show that the move toward greater transparency (centralization) may have detrimental effects on liquidity and welfare.
Accepted Paper Series
Date posted: December 3, 2003
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