Working Paper: CEPR ID: DP4091
Authors: Thierry Foucault; Sophie Moinas; Erik Theissen
Abstract: We analyse the effect of concealing limit order traders? identities on market liquidity. We develop a model in which limit order traders have asymmetric information on the cost of limit order trading (which is determined by the exposure to informed trading). A thin limit order book signals to uninformed bidders that the profitability of limit orders is small. This deters uninformed bidders from improving upon the posted quotes. Informed bidders exploit this effect by bidding as if the cost of liquidity provision were large when indeed it is small. This bluffing strategy is less effective when traders cannot distinguish between informative and uninformative limit orders. Hence informed bidders act more competitively in the anonymous market. For this reason, concealing limit order traders? IDs affects market liquidity in our model. We test this prediction using a natural experiment. On April 23, 2001, the limit order book for stocks listed on Euronext Paris became anonymous. We find that following this change, the average quoted spreads declined significantly whereas the quoted depth decreased.
Keywords: anonymity; limit order trading; liquidity; market microstructure; transparency
JEL Codes: G10; G14; G24
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Concealing limit order traders' identities (D41) | Average quoted spreads (G19) |
| Concealing limit order traders' identities (C69) | Quoted depth (Y60) |
| Concealing limit order traders' identities (D41) | Informed traders act more competitively (D83) |
| Informed traders act more competitively (D83) | Average quoted spreads (G19) |
| Informed traders act more competitively (D83) | Quoted depth (Y60) |