Price Manipulation in Parallel Markets with Different Transparency

Abstract

We study how dealers behave when there exist parallel markets for the same asset that are characterized by very different degrees of transparency. We show that the optimal trading strategy, depending on the features of the less transparent market and on the informational uncertainty in the more transparent one, may involve price manipulation. Specifically, informed dealers may refrain from trading in the more transparent market in order to exploit their informational advantage in the less transparent one, or they may use the more transparent market in order to manipulate prices. We show that both strategies (hiding and price manipulation) increase market depth in the more transparent market. We test the empirical implications of our model on the Italian Treasury bond market. We estimate dealers's strategies on both the primary and the secondary markets. We find that informed dealers place sell orders with other dealers at the time they have higher informational advantage and, at the same time, aggressively place bids in the primary market. This strategy generates losses in the more transparent market (secondary market) for the period during which the less transparent market (primary market) is open and then produces gains once the possibility of affecting the primary market is over. We find that, consistent with our model, market depth in the more transparent market increases as a result of these trading strategies. This supports the findings of Bloomfield and O'Hara (1999 and 2000) and shows how the existence of a less transparent market, far from reducing the liquidity of the more transparent market, may actually increase it.