Who Acquires Information in Dealer Markets?

Abstract

We study information acquisition in dealer markets. We first identify a one-sided strategic complementarity in information acquisition: the more informed traders are, the larger market makers' gain from becoming informed. When quotes are observable, this effect in turn induces a strategic complementarity in information acquisition amongst market makers. We then derive the equilibrium pattern of information acquisition and examine the implications of our analysis for market liquidity and price discovery. We show that increasing the cost of information can decrease market liquidity and improve price discovery.

Keywords: Market Microstructure, Informed Market Makers, Dealer Markets, Information Acquisition

JEL Classification: D82, D83, G12, G14, G20