DP4091 Does Anonymity Matter in Electronic Limit Order Markets?

Author(s): Thierry Foucault , Sophie Moinas , Erik Theissen

Publication Date: October 2003

Keyword(s): market microstructure , limit order trading , anonymity , transparency , liquidity

JEL(s): G10 , G14 , G24

Programme Areas: Financial Economics

Link to this Page: www.cepr.org/pubs/dps/DP4091.asp

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.