Who Sees the Trades? The Effect of Information on Liquidity in Inter-Dealer Markets

Garratt, Rod; Lee, Michael Junho; Martin, Antoine; Townsend, Robert M.

Report

Who Sees the Trades? The Effect of Information on Liquidity in Inter-Dealer Markets

Abstract: Dealers, who strategically supply liquidity to traders, are subject to both liquidity and adverse selection costs. While liquidity costs can be mitigated through inter-dealer trading, individual dealers? private motives to acquire information compromise inter-dealer market liquidity. Post-trade information disclosure can improve market liquidity by counteracting dealers? incentives to become better informed through their market-making activities. Asymmetric disclosure, however, exacerbates the adverse selection problem in inter-dealer markets, in turn decreasing equilibrium liquidity provision. A non-monotonic relationship may arise between the partial release of post-trade information and market liquidity. This points to a practical concern: a strategic post-trade platform has incentives to maximize adverse selection and may choose to release information in a way that minimizes equilibrium liquidity provision.

Keywords: inter-dealer markets; liquidity; information design; platforms;

JEL Classification: D62; D82; G14; G23;