Does Anonymity Matter in Electronic Limit Order Markets?

Abstract

We analyze the effect of concealing limit order traders' identities on market liquidity. First we develop a model in which limit order traders have asymmetric information on the true cost of limit order trading (which is determined by the exposure to informed trading). Uninformed bidders draw inferences on this cost from the state of the book. A thin book can be due to untapped profit opportunities or a high cost of limit order trading. The last possibility reduces uninformed bidders' inclination to add depth when the book is thin. Informed bidders exploit this effect by bidding less aggressively than when bidders have symmetric information. However they bid more aggressively when their identities are concealed than when they are disclosed. For this reason, concealing limit order traders' IDs affects market liquidity in our model. We test this prediction using a natural experiment. On April 23, 2001, the limit order book for stocks listed on Euronext Paris became anonymous. We find that following this change, the average quoted spreads declined significantly whereas the quoted depth decreased.

Keywords: Natural Experiment, Limit Order Book, Anonymity, Liquidity