Hiding Behind the Veil: Pre-Trade Transparency, Informed Traders and Market Quality

Abstract

This paper investigates, from a market design perspective and in the context of informed trading and liquidity supply, the trade-offs or positive associations between pre-trade transparency and the different dimensions of market quality in the rapidly proliferating electronic order-book markets. We find that financial institutional investors are more informed than other investors and prefer to restrict pre-trade transparency, through the use of hidden orders, when they supply liquidity. Specifically, they choose to restrict pre-trade transparency when their orders and trades impound information. Restricting pre-trade transparency leads to more efficient price discovery and better market quality. These results also hold when pre-trade transparency and market quality are determined endogenously.