Optimal Transparency in a Dealership Market with an Application to Foreign Exchange

Posted: 10 Sep 1999

See all articles by Richard K. Lyons

Richard K. Lyons

University of California, Berkeley; National Bureau of Economic Research (NBER)

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Date Written: August 1994

Abstract

This paper shows there is a tradeoff between the speed of revelation and risk sharing in markets organized like spot foreign exchange. We show this by examining the following question: Would risk-averse dealers prefer ex-ante that order flow were observable? We answer this question with the solution to a mechanism design problem. The resulting incentive-efficient mechanism is one in which order flow is not generally observable. Rather, dealers prefer slower revelation because it permits additional risk-sharing. Specifically, additional trading opportunities in advance of revelation lowers the variance of unavoidable position disturbances, thereby reducing the marketmaking risk inherent in price discovery. We apply the framework to the spot foreign exchange market in order to understand better the current degree of transparency in that market.

JEL Classification: G15, G14

Suggested Citation

Lyons, Richard K., Optimal Transparency in a Dealership Market with an Application to Foreign Exchange (August 1994 ). Available at SSRN: https://ssrn.com/abstract=5559

Richard K. Lyons (Contact Author)

University of California, Berkeley ( email )

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