Review of Quantitative Finance and Accounting, 18: 21–38, 2002
2002 Kluwer Academic Publishers. Manufactured in The Netherlands.
Trade Disclosure, Information Learning and Securities
Abstract. In this paper we examine the effect of information disclosure on securities market performance when
liquidity traders are able to acquire information about inside trading. We show that the bid-ask spread increases
with the liquidity trader’s learning efﬁciency, which is greater when trade information is disclosed. The bid-ask
spread is always higher when trade information is not disclosed. However, the discrepancy between the bid-ask
spreads with and without information disclosure narrows when the learning efﬁciency increases. We also show that
the gains of the informed traders in a market without trade information disclosure are reduced in the presence of the
liquidity trader’s learning. Nevertheless, liquidity traders do not necessarily beneﬁt from increased transparency.
In particular, liquidity traders may face higher trading costs.
Key words: market transparency, fragmentation, and Bayes-Nash equilibrium
JEL Classiﬁcation: G14, G15
In this paper we propose a Bayesian model along the line of Easley and O’Hara (1992) and
Madhavan (1995) to examine the effects of public trade disclosure on information efﬁciency,
bid-ask spreads, price volatility and traders’ welfare in a competitive dealer market. Unlike
these studies, we permit learning by liquidity traders in a dealer market. This structure
differs from the standard setting of Bayesian equilibrium models in that liquidity traders
may infer from the past trades and quotes the likelihood of an informed trader’s arrival. This
is because the information for an informed trader’s arrival is embedded in dealers’ quotes.
In reality, liquidity traders may also infer the likelihood of informed trading from trade size,
other parties in a negotiated market or new agencies. Under these circumstances, liquidity
traders’ willingness to buy or sell depends on their inference on the probability of informed
traders’ arrival. Our approach contrasts previous studies that assume liquidity traders arrive
randomly and no learning takes place between trades.
We demonstrate that in the presence of learning by liquidity traders, the beneﬁt enjoyed
by informed traders in a market without trade disclosure is signiﬁcantly reduced. We show
that bid-ask spreads in a market with and without trade disclosure are a positive function
of the learning efﬁciency of liquidity traders. One important consequence of this is that the
Address correspondence to: School of Management, Syracuse University, Syracuse, NY 13244-2130.