Transparency and bypass in electronic financial markets

Electronic financial markers use information technology to disseminate prices, quantities, and buyer and supplier identities. In spite of their recognized benefits, increased visibility and transparency may introduce imperfections, and create profitable opportunities to bypass markets. In the US, dissemination of market data has equipped several firms to develop competing, off-exchange trading mechanisms that rely on central market price data, but whose transactions bypass the established market. Significant trading away from the principal market may reduce market quality, and increase transaction costs. A simulation model of trading in a continuous auction market (similar to the market structure of the New York Stock Exchange) is used to examine the effects of increasing levels of trading activity through an off-exchange dealer. The results indicate that competition from an alternative trading venue reduces some trading costs borne by some investors. Contrary to regulatory goals however, off-market trading expands the role of profit-seeking dealers, and lowers the probability that some investors' orders will execute.<
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