Does Anonymity Matter in Electronic Limit Order Markets?

We analyze the effect of concealing limit order traders' identities on market liquidity. We develop a model in which limit order traders have asymmetric information on the cost of limit order trading (which is determined by the exposure to informed trading). A thin limit order book signals to uninformed bidders that the profitability of limit orders is small. This deters uninformed bidders from improving upon the posted quotes. Informed bidders exploit this effect by bidding as if the cost of liquidity provision were large when indeed it is small. This bluffing strategy is less effective when traders cannot distinguish between informative and uninformative limit orders. Hence informed bidders act more competitively in the anonymous market. 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.

[1]  Martin Hellwig,et al.  On the aggregation of information in competitive markets , 1980 .

[2]  Paul R. Milgrom,et al.  LIMIT PRICING AND ENTRY UNDER INCOMPLETE INFORMATION: AN EQUILIBRIUM ANALYSIS' , 1982 .

[3]  George Tauchen,et al.  THE PRICE VARIABILITY-VOLUME RELATIONSHIP ON SPECULATIVE MARKETS , 1983 .

[4]  Dan Galai,et al.  Information Effects on the Bid‐Ask Spread , 1983 .

[5]  Joseph E. Harrington,et al.  Oligopolistic Entry Deterrence under Incomplete Information , 1987 .

[6]  Albert S. Kyle,et al.  Informed Speculation with Imperfect Competition , 1989 .

[7]  Duane J. Seppi.  Equilibrium Block Trading and Asymmetric Information , 1990 .

[8]  Ekkehart Boehmer,et al.  Event-study methodology under conditions of event-induced variance , 1991 .

[9]  Paul C. Pfleiderer,et al.  Sunshine Trading and Financial Market Equilibrium , 1991 .

[10]  Alan J. Marcus,et al.  What's special about the specialist? , 1992 .

[11]  Maureen O'Hara,et al.  Time and the Process of Security Price Adjustment , 1992 .

[12]  Thomas J. George,et al.  Anonymity in securities markets , 1992 .

[13]  Duane J. Seppi.  Block Trading and Information Revelation around Quarterly Earnings Announcements , 1992 .

[14]  Joel Hasbrouck,et al.  Assessing the Quality of a Security Market: A New Approach to Transaction-Cost Measurement , 1993 .

[15]  Tim Bollerslev,et al.  Trading Patterns and Prices in the Interbank Foreign Exchange Market , 1993 .

[16]  Charles M. C. Lee,et al.  Spreads, Depths, and the Impact of Earnings Information: An Intraday Analysis , 1993 .

[17]  Christopher G. Lamoureux,et al.  Forecasting Stock-Return Variance: Toward an Understanding of Stochastic Implied Volatilities , 1993 .

[18]  Charles M. Jones,et al.  Transactions, Volume, and Volatility , 1994 .

[19]  L. Glosten.  Is the Electronic Open Limit Order Book Inevitable , 1994 .

[20]  Tim Bollerslev,et al.  Chapter 49 Arch models , 1994 .

[21]  Maureen O'Hara,et al.  Market Microstructure Theory , 1995 .

[22]  Chester Spatt,et al.  An Empirical Analysis of the Limit Order Book and the Order Flow in the Paris Bourse , 1995 .

[23]  Lawrence Harris,et al.  Market vs. Limit Orders: The SuperDOT Evidence on Order Submission Strategy , 1996, Journal of Financial and Quantitative Analysis.

[24]  Robert F. Engle,et al.  The Econometrics of Ultra-High Frequency Data , 1996 .

[25]  L. Harris.  Does a Large Minimum Price Variation Encourage Order Exposure , 1996 .

[26]  Michael A. Goldstein,et al.  Quotes, Order Flow, and Price Discovery , 1997 .

[27]  Robert E. Verrecchia,et al.  Pre-announcement and event-period private information , 1997 .

[28]  Ananth Madhavan,et al.  In Search of Liquidity: Block Trades in the Upstairs and Downstairs Markets , 1997 .

[29]  Thierry Foucault,et al.  Order flow composition and trading costs in a dynamic limit order market 1 I am grateful to Bruno Bi , 1999 .

[30]  Erik Theissen,et al.  Trader Anonymity, Price Formation and Liquidity , 2000 .

[31]  Thierry Foucault,et al.  Market Making with Costly Monitoring: An Analysis of the SOES Controversy , 2003 .

[32]  Paul J. Irvine,et al.  Liquidity Beyond the Inside Spread: Measuring and Using Information in the Limit Order Book , 2000 .

[33]  J. Rochet,et al.  COMPETING MECHANISMS IN A COMMON VALUE ENVIRONMENT , 2000 .

[34]  Ananth N. Madhavan,et al.  Price Discovery in Auction Markets: A Look Inside the Black Box , 2000 .

[35]  The Quality of the Italian Treasury Bond Market, Asymmetric Information and Transaction Costs , 2000 .

[36]  Kalok Chan,et al.  Limit Orders, Depth, and Volatility: Evidence from the Stock Exchange of Hong Kong , 2001 .

[37]  B. Rindi,et al.  Transparency, Liquidity and Price Formation , 2002 .

[38]  'Informed' Limit Order Trading , 2001 .

[39]  Market Efficiency and Price Formation When Dealers are Asymmetrically Informed , 2001 .

[40]  Thierry Foucault,et al.  Limit Order Book as a Market for Liquidity , 2001 .

[41]  Ohad Kadan,et al.  Limit Order Book as a Market for Liquidity , 2001 .

[42]  Robert J. Bloomfield,et al.  The 'Make or Take' Decision in an Electronic Market: Evidence on the Evolution of Liquidity , 2002 .

[43]  A. Roth,et al.  Last-Minute Bidding and the Rules for Ending Second-Price Auctions: Evidence from eBay and Amazon Auctions on the Internet , 2002 .

[44]  M. Nimalendran,et al.  Market Structure and Trader Anonymity: An Analysis of Insider Trading , 2003, Journal of Financial and Quantitative Analysis.

[45]  M. Ready,et al.  Credit Ratings and Stock Liquidity , 2003 .

[46]  Christine A. Parlour,et al.  Liquidity-Based Competition for Order Flow , 2003 .

[47]  David K. Whitcomb,et al.  Market Maker Quotation Behavior and Pretrade Transparency , 2003 .

[48]  P. Schultz.  Who makes markets , 2003 .

[49]  Gideon Saar,et al.  Lifting the Veil: An Analysis of Pre-Trade Transparency at the Nyse , 2003 .

[50]  W. Davidson,et al.  The predictive power of implied volatility: Evidence from 35 futures markets , 2003 .

[51]  Randi Naes,et al.  Order Book Characteristics and the Volume-Volatility Relation: Empirical Evidence from a Limit Order Market , 2004 .

[52]  Charles Cao,et al.  The Informational Content of an Open Limit Order Book , 2004 .