Screen informed and uninformed credit issuers
In this section we return to the transparency of financial markets, which was introduced in Chapter 1. The degree of transparency is relevant because it influences traders’ strategies, hence the pricing process. However, given the great variety of aspects, assessing the effects of pre-trade transparency on market quality is complicated, so it is not surprising that the results offered by the literature differ significantly depending on the market structure considered and the type of information revealed.
If one models transparency as the increased visibility of the liquidity suppliers’ order flows, the effects of pre-trade transparency on market quality will show the benefits of the reduction in adverse selection costs for liquidity and uninformed traders’ welfare.
Clearly, when liquidity suppliers can screen informed and uninformed traders, they can also offer liquidity on better terms to the uninformed. If, however, pre-trade transparency is modelled as the visibility of traders’ identification codes, the effects on market quality can differ, as has been shown by Foucault, Moinas and Theissen (2007) and Rindi (2008). Finally, an often-debated question is the relationship between clients and intermediaries, given that the latter enjoy privileged information on the motivation for their clients’ trades and can exploit this by acting as a counterpart in the trades (dual capacity trading (Röell, 1990) or trading before the clients (front running)).
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