Risk Aversion, Transparency, and Market Performance


  • M. Ángeles De Frutos,

  • Carolina Manzano

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    • de Frutos is from the Department of Economics, Universidad Carlos III de Madrid, and Manzano is from the Department of Economics, Universitat Rovira i Virgili. We thank Jordi Caballé, Michael Manove, Lambros Pechlivanos, Ignacio Peña and Mikel Tapia for helpful comments. Valuable suggestions by the editor and the referee have substantially improved the paper. Financial support of grant BEC2000–0173 for the first author, and grant DGES PB97–0084 for the second author, is gratefully acknowledged.


Using a model of market making with inventories based on Biais (1993), we find that investors obtain more favorable execution prices, and they hence invest more, when markets are fragmented. In our model, risk-averse dealers use less aggressive price strategies in more transparent markets (centralized) because quote dissemination alleviates uncertainty about the prices quoted by other dealers and, hence, reduces the need to compete aggressively for order flow. Further, we show that the move toward greater transparency (centralization) may have detrimental effects on liquidity and welfare.