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RFS Advance Access published online on August 25, 2004
Review of Financial Studies, doi:10.1093/rfs/hhi005
Review of Financial Studies © The Society for Financial Studies 2004; all rights reserved
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Original Articles

Anonymity, Adverse Selection and the Sorting of Interdealer Trades1

Peter C. Reiss 1 Ingrid M. Werner 2*
1 Graduate School of Business, Stanford University, 215 Littlefield Hall, Stanford, California 94305
2 Fisher College of Business, The Ohio State University, 2100 Neil Avenue, Columbus, Ohio 43210

* To whom correspondence should be addressed. E-mail: werner{at}cob.osu.edu.


  Abstract

This paper uses unique data from the London Stock Exchange to examine how trader anonymity and market liquidity a[ff]ect dealers' decisions about where to place interdealer trades. During our sample period, dealers could trade with each other in the direct, nonanonymous public market or use one of four anonymous brokered trading systems. Surprisingly, we find that adverse selection is less prevalent in the anonymous brokered markets. We show that this pattern can be explained by the way dealers "price" the adverse selection risk inherent in trading with other dealers. We also relate our findings to recent changes in dealer markets.

1 We thank Maureen O'Hara and two anonymous referees for helpful comments. We also thank Bill Christie, Joel Hasbrouck, Paul Pfleiderer, Jeff Zwiebel, and seminar audiences at Copenhagen Business School, Fisher College of Business, Handelshoyskolen - BI, Stockholm University - IIES, University of Cincinnati, University of Georgia, and participants at the 1999 Notre Dame Market Microstructure Conference and WFA meetings. Lee Bath Nelson provided expert research assistance. We obtained data from the Quality of Markets Group at the London Stock Exchange, and we specially thank Stephen Wells and Graham Hart for their assistance in interpreting the data. Both authors received support from Stanford Financial Research Initiative. The usual disclaimer applies.


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