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Title: Market Transparency and Fragility

Author(s): Giovanni Cespa and Xavier Vives

Publication Date: December 2016

Keyword(s): asymmetric information, flash crash, liquidity fragility and market fragmentation

Programme Area(s): Financial Economics

Abstract: We show that dealers' limited market participation, coupled with an informational friction resulting from lack of market transparency, can make liquidity demand upward sloping, inducing strategic complementarities: traders demand more liquidity when the market becomes less liquid, fostering market illiquidity. This can generate instability with an initial dearth of liquidity degenerating into a liquidity rout (as in a flash crash). In a fully transparent market, liquidity is increasing in the proportion of dealers continuously present in the market; however, in a less transparent market, liquidity can be U-shaped in this proportion and in the degree of transparency.

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Bibliographic Reference

Cespa, G and Vives, X. 2016. 'Market Transparency and Fragility'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=11732