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Information and the Intermediary: Are Market Intermediaries Informed Traders in Electronic Markets?

Published online by Cambridge University Press:  06 April 2009

Amber Anand  and
Avanidhar Subrahmanyam
Amber Anand
Affiliation:
amanand@syr.edu, Whitman School of Management, Syracuse University, 721 University Avenue, Syracuse, NY 13244;
Avanidhar Subrahmanyam
Affiliation:
subra@anderson.ucla.edu, Anderson Graduate School of Management, University of California at Los Angeles, 110 Westwood Plaza, Los Angeles, CA 90095.
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Abstract

A significant but unresolved question in the current debate about the role of intermediaries in financial markets is whether intermediaries behave as passive traders or whether they actively seek and trade on information. We address this issue by explicitly comparing the informational advantages of intermediaries with those of other investors in the market. We find that intermediaries account for greater price discovery than other institutional and individual investors in spite of initiating fewer trades and volume. Furthermore, intermediary information does not arise from inappropriate handling of customer orders by intermediaries. We propose that our findings are consistent with noisy rational expectations models, where agents extract valuable information from past prices. Intermediaries bear little or no opportunity cost of monitoring market conditions, which gives them an advantage in making profitable price-contingent trades. Lower trading costs may also enable intermediaries to trade more effectively and frequently on their information.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 43 , Issue 1 , March 2008 , pp. 1 - 28
Copyright
Copyright © School of Business Administration, University of Washington 2008

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