Knowledge that Transforms

Many recommendations for reforming securities markets are predicated on the belief that providing information on order flow and other market variables to traders (i.e., increasingmarket transparency) will increase liquidity and improve price efficiency. This paper demonstrates that market transparency can actually increase price volatility and lower market liquidity. This occurs even though transparency increases the precision of traders' predictions about the asset's value. In a sufficiently large market, transparency always reduces volatility and improves market quality. We use these results to assess various policy proposals concerning the disclosure of trading information.Journal of Economic Literature Classification Numbers:D82, D83, G12, G14.

In the presence of economies of scale, depositors' expectations are shown to give rise to vertical differentiation and to yield multiple market equilibria, some of which exhibit institutional or systemic collapse. This fragility is due to a coordination problem among depositors and not to bank competition. Nevertheless, failure perceptions do influence rivalry which in turn affects the failure probability in particular equilibria. Deposit insurance improves welfare by preventing collapse, extending the market, and minimizing frictions. However, deposit insurance also may induce fiercer competition for deposits and increase the deadweight losses associated with failing institutions. The welfare impact of deposit insurance is shown to depend on market structure, and is thus ambiguous even in a world of full liability and no moral hazard in bank investments.Journal of Economic LiteratureClassification Numbers: G21, G28.

The AMEX changed the tick size from[formula]to[formula]for low-price stocks on September 3, 1992. Consistent with the prediction of L. E. Harris (1994, Minimum price variations, discrete bid–ask spreads, and quotation sizes,Rev. Finan. Stud.7,149–178), the change has reduced both quoted and effective spreads, although the magnitude of the reduction is much smaller than predicted. However, we fail to find evidence of a significant increase in trading volume. Our cross-sectional regressions show that stocks with greater trading activity, lower prices, and stronger competition from the regional exchanges experienced greater spread reductions.Journal of Economic LiteratureClassification Numbers: G10, G18, G20.

This paper models inside trading regulation with a well-defined objective and introduces an explicit measure of regulatory strictness. The regulator's objective is to minimize the trading loss of liquidity traders. With market professionals whose information-based trading is not regulated, the objective of regulation can be achieved by promoting competition between these market professionals and the insider. When stricter regulation induces improvement in the precision of the market professionals' information, tolerating some insider trading can be the optimal regulatory policy. It is also shown that allowing more market professionals to enter the market and disclosing information to them are as effective in achieving the regulatory objective as the direct restriction of insider trading.Journal of Economic LiteratureClassification Numbers: D82, G10, L13.