Transparency and Liquidity: A Comparison of Auction And Dealer Markets with Informed Trading

It is often argued that greater transparency of the trading process enhances market liquidity by reducing the opportunities for taking advantage of less informed participants. We provide a model to investigate a possible basis for this view. We compare the price formation process in several trading systems, that differ in their degree of transparency: an ideal fully transparent auction, a continuous auction, a batch auction and a stylized dealer market. We show that the presumption that greater transparency generates lower trading costs for uninformed traders has an analytical basis, but that it needs important qualifications as a general statement. 

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