Abstract
This paper studies how mandatory transparency (through TRACE), along with long term incentive of informed dealers, affect market price informativeness, liquidity and welfare in dynamic over-the-counter (OTC) markets. We show public disclosure of additional information about past trades, paradoxically, makes the markets more opaque, by reducing market price informativeness. Thus, surprisingly, the transparency requirements of the U.S. Dodd-Frank Act may make the markets more opaque. However, this market opacity creates liquidity and increases welfare. To enhance financial transparency via improving price informativeness as well as market liquidity and welfare, an effective way is to randomly audit dealers.
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