شفافیت قبل از معامله و کیفیت بازار

There is no consensus in the literature on whether an increase in pre-trade transparency results in an improvement or deterioration in market quality. Two discrete changes in pre-trade transparency on the Korea Exchange (KRX), an electronic order-driven market, allow us to address this question. We find that market quality is increasing and concave in pre-trade transparency, with significantly diminishing returns above a certain point. We argue that previous event studies of the effect of transparency have been econometrically flawed, propose a procedure to correct this flaw, and show that this procedure can reverse the result of an event study.

Pre-trade transparency in stock markets is generally defined as a measure of the public release of information concerning participants’ buy and sell orders before these orders are executed. 1 In this paper, we study the effect of pre-trade transparency on market quality using an event study. Changes in pre-trade transparency have an effect on stock market quality through the following two channels. First, each trader adjusts his/her inferences concerning the true value of the stock and optimal strategy in direct response to the change in the quote disclosure rule. Second, each trader must further adjust his/her optimal strategy in response to the changes in the strategies of other agents; eventually, the market will reach a new equilibrium state in which traders make no further adjustments in their strategies. The appropriate level of pre-trade transparency is a policy variable that can be freely set by an exchange or by regulators. The fundamental economic question to be addressed in setting this policy variable is whether an increase in pre-trade transparency results in an improvement or a deterioration in market quality. Because there have been relatively few real-world events in which the disclosure policy changed, there have been relatively few studies of the effects of pre-trade transparency on market quality. Moreover, the few previous studies disagree on whether an increase in pre-trade transparency results in an increase or a decrease in market quality. Madhavan, Porter, and Weaver (2005) analyze pre-trade transparency using real-world data. Analyzing the effects of the event in which the Toronto Stock Exchange (TSX) started to publicly disclose the limit order book of both the floor and the Computer Aided Trading System (CATS), Madhavan, Porter, and Weaver (2005) found that the increase in pre-trade transparency had detrimental effects on market quality. Specifically, they found that the increased transparency resulted in higher trade execution costs and volatility, and that the effects were concentrated in floor stocks where pre-trade transparency was previously low and not in CATS stocks that already featured a high degree of information disclosure. Their analysis controlled for certain relevant variables such as volume and volatility in cross-section, but since these control variables are endogenous, the cross-sectional analysis is misspecified. In contrast, Baruch (2005) developed a theoretical model in which he argued that an increase in pre-trade transparency increases market quality by reducing spreads and increasing the informational efficiency of the price. Using the introduction of NYSE's OpenBook “for payment” in 2002 as an event, Boehmer, Saar, and Yu (2005) found that greater pre-trade transparency of the limit order book is a win-win situation, the opposite to the finding of Madhavan, Porter, and Weaver (2005). Hendershott and Jones (2005a) found that a reduction in the transparency of the order book of the Island ECN, the dominant market for the three most active ETF's, decreased market quality.2 Thus, there is no consensus in the literature on whether increasing pre-trade transparency results in an improvement in market quality. Our study makes use of two events on the Korea Exchange (KRX)3, an electronic order-driven market. The KRX publicly discloses a specified number of the best buy and sell prices and the number of shares desired or offered at those prices. On March 6, 2000, the number of publicly disclosed prices (and the number of shares at each price) was increased from 3 (the bid and the next two best buy prices, the ask and the next two best sell prices) to 5 (hereafter, “2000 event”), and from 5 to 10 on January 2, 2002 (hereafter, “2002 event”). These two discrete changes in the disclosure policy allow us to address the effect of pre-trade transparency on market quality. We have three main findings: • Market quality is increasing in pre-trade transparency. • Market quality is concave in pre-trade transparency, and the benefits of providing additional pre-trade disclosure are significantly diminishing above a certain point. • Previous event studies have obtained mixed results on the sign of the effect of pre-trade transparency on market quality. We argue that this may be due to a methodological flaw in those studies, propose a procedure to correct this flaw, and show that this procedure can reverse the result of an event study. The rationale for the 2000 event was very simple: the KRX viewed the level of quote disclosure as too low. In increasing the disclosure, they were following the widespread belief among policy makers that increasing transparency leads to a fairer and informationally more efficient market (see US SEC, 1994). In contrast, the 2002 event involved two changes, with different motivations. The main change, as noted above, was to increase the number of publicly disclosed quotes on each side of the market from 5 to 10; this was motivated by the belief that increasing transparency improves market quality. The second change involved a reduction in disclosure. Prior to the 2002 event, the KRX publicly disclosed the sum of the numbers of shares offered or sought at all prices on each side of the order book, without disclosing the prices associated with those orders unless those prices were among the 5 best on each side. This policy allowed traders to post misleading information by placing large limit orders at prices far from the market price, creating the impression of a large order imbalance with very little risk that the orders would be executed.4 At the 2002 event, the KRX stopped disclosing this information in order to prevent the public posting of misleading information.5 Using standard event-study methodology, we find that the 2000 event unambiguously increased market quality. By contrast, using standard event-study methodology, the 2002 event appears on balance to decrease market quality. Only two of the tests, using relative spread and full-information trade cost, show improvement in market quality, while the other test statistics are mostly positive, indicating a decline in market quality, with some statistically significant and others not. Event studies are based on the assumption that other relevant variables do not change from before to after the event, or if they do change, they can be adequately controlled. If that assumption is not satisfied, then changes in these other relevant variables may contaminate the event study. If the other relevant variables are exogenous, then controlling is straightforward. However, in market microstructure event studies, critical variables are endogenously determined, so that cross-sectional control methods are inapplicable. In particular, in event studies of market quality, variables such as volume and price are known to affect market quality; however, because they are determined endogenously, some studies have not bothered to control for them, while other studies have controlled for them using inapplicable procedures; in either case, the results of the event studies are contaminated. We reran our analyses of the two events, controlling for volume and price using a panel-data design. We computed the standard errors in two ways: OLS, and the clustered standard errors method (Rogers, 1993), clustering by time.6 We confirmed our uncontrolled finding that market quality was unambiguously improved by the 2000 event. However, our uncontrolled finding that market quality was probably decreased by the 2002 event is reversed. Using appropriate controls, we find evidence that market quality improved following the 2002 event; the evidence appears convincing using the OLS standard errors, but weaker using the Rogers standard errors. We conclude that market quality is an increasing concave function of pre-trade transparency, with significantly decreasing returns to transparency above the level of disclosure established by the 2000 event. Like those earlier empirical papers, our paper examines the relationship between pre-trade transparency and market quality using real-world data around a specific change in disclosure regime. However, our paper differs from those papers in the following ways. First, we analyze an electronic order-driven market in which there is no market maker. The pre-trade transparency in the electronic order-driven market provides a public measure of traders’ willingness to supply liquidity to the market using limit orders. Since there are no specialists or dealers, this is the only source of liquidity in this type of market. Second, we examine whether pre-trade transparency and market quality are monotonically related using a series of events. Third, following Madhavan, Richardson, and Roomans (1997, hereafter MRR), we decompose the trade execution cost into two components: adverse selection cost from asymmetric information among traders and transitory cost, and analyze the effect of pre-trade transparency on each component. The MRR decomposition was previously used to study the effect of pre-trade transparency by Madhavan, Porter, and Weaver (2005), but only to analyze one component (adverse selection cost). In order to analyze comprehensively the relationship between pre-trade transparency and market quality, we set up six null hypotheses on market stability and informational efficiency of the price, reflecting the multi-faceted characteristics of market quality.7 Each of the six hypotheses has the following basic structure: market quality is unchanged after the event compared to before the event. Negative rejections indicate a statistically significant improvement in market quality, while positive rejections indicate a statistically significant deterioration. In our tests, we use six measures of market quality (bid-ask spread (hereafter spread) and relative spread, market depth, transient volatility, market-to-limit order ratio, Bandi and Russell (2006, hereafter BR) full-information trade cost (FITC), and MRR implied spread); and two components of the MRR implied spread (adverse selection cost and transitory cost).8 We analyze the changes in the variables from before to after each of the two events. Since we have two events in the same market, we are able to assess whether the effect of pre-trade transparency on market quality is monotonic, and whether it is concave or convex. We use two methods: a standard event-study method, without controlling for other relevant variables; and a panel-data analysis, controlling for the endogenous variables volume and price. Since regulatory changes in stock markets generally are relatively rare, one-time, events, two factors could possibly limit the significance of our results. The first is the statistical power of the test results. As Boehmer, Saar, and Yu (2005) point out, “this is an investigation of [two events] and therefore our statistical ability to attribute changes to the [events is] limited.” This is an intrinsic limitation in the analysis of events that occur very rarely (see Schwert, 1981). The second factor comes from the slight heterogeneity of our two events. As we mentioned above, the 2002 event is like the 2000 event in the sense that it expanded the number of publicly disclosed quotes and sizes. However, unlike the 2000 event, it also reduced disclosure in a minor way: it stopped disclosing the sum of the numbers of shares offered or sought at all prices on each side of the order book. The decision to reduce disclosure in this way was based on a concern that some traders were manipulating the information flow by placing large orders that had little chance of being executed because they were far from the current market price. Since the elimination of this possible manipulation was intended to improve the quality of the pre-trade disclosure,9 we view it as an increase of pre-trade transparency. With these caveats, our results are as follows. First, when we correct for endogenous variables using a panel-data analysis, market quality improves following both the 2000 and 2002 events, indicating that market quality is monotonically increasing in pre-trade disclosure. Second, the improvement in market quality following the 2002 event is much lower than that following the 2000 event, indicating that market quality is a concave function of pre-trade transparency, with significantly diminishing returns above the level of disclosure established by the 2000 event. Third, using standard event-study methodology without correcting for relevant variables, the analysis of the 2000 event shows an improvement in market quality, but the 2002 event shows a mixed picture which, on balance, suggests a decrease in market quality. Thus, it is important in market microstructure event studies to correct for relevant endogenous variables using a panel-data analysis. The remainder of this paper is organized as follows. Section 2 describes our standard event-study and panel-data methodologies. Section 3 details our testable hypotheses. Section 4 describes the sampling of firms and provides descriptive statistics of our data. Section 5 presents and interprets the empirical results and their implications. Section 6 provides a summary of our results and some suggestions for further research.

We examine the effect of pre-trade transparency on market quality. For this, we analyze two real-world events undertaken by the KRX, which increased the number of publicly disclosed quotes from 3 to 5 on March 6, 2000 and from 5 to 10 on January 2, 2002. We measure market quality using spread, relative spread, market depth, transient volatility, market-to-limit order ratio, BR FITC, MRR implied spread and its adverse selection and transitory cost components. We compare measures of market quality before and after the events using standard event-study methodology, which indicates an improvement in market quality following the 2000 event, but a deterioration in market quality following the 2002 event. Because the standard event-study methodology does not control for the relevant variables volume or price, and because these variables are endogenous, we conduct a panel-data analysis. This analysis indicates that both events improved market quality, confirming the finding of the standard event-study methodology for the 2000 event, but reversing the finding for the 2002 event. We conclude that market microstructure event studies should use panel-data analyses to control for relevant endogenous variables to ensure the reliability of their results. The panel-data study indicates that the improvement in market quality was much smaller following the 2002 event, indicating that market quality is a concave function of pre-trade transparency. We attempt to analyze the relationship between pre-trade transparency and market quality in a comprehensive way. We did not have access to information on each trader’s type (individual versus institutional, domestic versus foreign) which might have provided more detailed results about the relationship of informational efficiency and pre-trade transparency on the KRX; we will pursue this in future research.