Who Sees the Trades? The Effect of Information on Liquidity in Inter-Dealer Markets
56 Pages Posted: 21 Jul 2019 Last revised: 7 Jul 2020
Date Written: July 1, 2019
Dealers, who strategically supply liquidity to traders, are subject to both liquidity and adverse selection costs. While liquidity costs can be mitigated through inter-dealer trading, individual dealers’ private motives to acquire information compromise inter-dealer market liquidity. Post-trade information disclosure can improve market liquidity by counteracting dealers’ incentives to become better informed through their market-making activities. Asymmetric disclosure, however, exacerbates the adverse selection problem in inter-dealer markets, in turn decreasing equilibrium liquidity provision. A non-monotonic relationship may arise between the partial release of post-trade information and market liquidity. This points to a practical concern: a strategic post-trade platform has incentives to maximize adverse selection and may choose to release information in a way that minimizes equilibrium liquidity provision.
Keywords: inter-dealer markets, liquidity, information design, platforms
JEL Classification: D62, D82, G14, G23
Suggested Citation: Suggested Citation