Market Transparency and Fragility
45 Pages Posted: 26 Feb 2019
Date Written: February 21, 2019
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
JEL Classification: G10, G12, G14
Suggested Citation: Suggested Citation