Can Transparent Markets Survive?
Posted: 1 Feb 2001
This paper investigates whether transparent markets can survive when faced with direct competition from less transparent markets. We first construct a game-theoretic model in which in equilibrium the low-transparency dealers capture early order flow, and use the resulting informational advantage to quote narrower spreads and earn more profits than their more transparent competitors. We then conduct a laboratory experiment that tests and supports all of these predictions. A second experiment shows that most dealers choose to be of lower transparency when they are allowed to do so. However, the informational advantage of low-transparency decreases as there are more such dealers, while the high-transparency dealers get increasing benefit from informed traders who attempt to broadcast deceptive trades. As a result, a small number of transparent dealers persist in our markets.
Keywords: Market microstructure, experimental economics, stock market competition
JEL Classification: G14; G12; D82
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