Informed Traders as Liquidity Providers: Transparency, Liquidity and Price Formation

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Abstract
I study the consequences,of pre-trade transparency,on liquidity in an order-driven market,with informed,and uninformed,risk-averse investors and liquidity traders. For a given proportion of informed agents, the more trans- parent the market, the more liquid it is. With endogenous information ac- quisition this result can be reversed, since greater transparency reduces the incentive to acquire information,and thus lowers the equilibrium number,of informed traders. This can reduce liquidity, since in this model informed agents are natural liquidity providers. Informed agents are in a good posi- tion to accommodate the liquidity shocks of liquidity traders, because they are not exposed to adverse selection. That transparency,can have ambiguous consequences,is in line with the results of empirical studies. JEL classiÞcation codes: D82, G28. Keywords: liquidity providers, pre-trade transparency, centralized mar- kets. 2

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