Journal of Financial Economics Vol. 55 No. 3 2000
Can transparent markets survive?
Abstract
This paper investigates whether transparent markets can survive when faced with direct competition from less transparent markets. We first construct a game-theoretic model in which in equilibrium the low-transparency dealers capture early order flow, and use the resulting informational advantage to quote narrower spreads and earn more profits than their more transparent competitors. We then conduct a laboratory experiment that tests and supports all of these predictions. A second experiment shows that most dealers choose to be of lower transparency when they are allowed to do so. However, the informational advantage of low-transparency decreases as there are more such dealers, while the high-transparency dealers get increasing benefit from informed traders who attempt to broadcast deceptive trades. As a result, a small number of transparent dealers persist in our markets.
- DOI
- 10.1016/s0304-405x(99)00056-2
- Volume
- 55
- Issue
- 3
- Pages
- 425-459
- Sources
- bibtex:phds-export.bib openalex crossref