Who Sees the Trades? The Effect of Information on Liquidity in Inter-Dealer Markets

51 Pages Posted: 21 Jul 2019

See all articles by Rodney Garratt

Rodney Garratt

University of California, Santa Barbara (UCSB)

Michael Junho Lee

Federal Reserve Banks - Federal Reserve Bank of New York

Antoine Martin

Federal Reserve Bank of New York - Research and Statistics

Robert M. Townsend

Massachusetts Institute of Technology (MIT)

Date Written: July 2019

Abstract

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

Garratt, Rodney and Lee, Michael Junho and Martin, Antoine and Townsend, Robert M., Who Sees the Trades? The Effect of Information on Liquidity in Inter-Dealer Markets (July 2019). FRB of New York Staff Report No. 892. Available at SSRN: https://ssrn.com/abstract=3422922 or http://dx.doi.org/10.2139/ssrn.3422922

Rodney Garratt

University of California, Santa Barbara (UCSB) ( email )

Michael Junho Lee (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

Antoine Martin

Federal Reserve Bank of New York - Research and Statistics ( email )

33 Liberty Street
New York, NY 10045
United States
212-720-6943 (Phone)

Robert M. Townsend

Massachusetts Institute of Technology (MIT) ( email )

77 Massachusetts Avenue
50 Memorial Drive
Cambridge, MA 02139-4307
United States

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