Competition and Information Leakage

Abstract

When seeking to trade in over-the-counter markets, institutional investors typically contact only a small number of potential counterparties and limit information disclosure (e.g., by asking for two-sided rather than one-sided quotes). We rationalize these behaviors in a model featuring endogenous front-running. Although contacting an additional dealer intensifies competition and aids in finding a natural counterparty, it also intensifies information leakage—which can be costly if it helps a losing dealer to front-run. Regarding information design, the client optimally provides no information about her desired trade when soliciting quotes. We also discuss implications for market design and regulation.

Keywords: principal trading, request for quotes (RFQ), information design, price impact, front- running

JEL Classification: D82, D83, G14, G23