Disclosure Regulation in Competitive Dealership Markets : Analysis of the London Stock Exchange

This paper presents a two stage trading model of a competitive dealership market. In the first stage, one among a group of risk averse market makers executes a public trade which contains some information. Details of this trade are not publicly disclosed. In the second stage, an inter-dealer market allows the market maker to offset her inventory position and exploit the information contained in the public order by trading with the other market makers. We show that the price of a trade in such a market depends in a nonlinear way on the informativeness and the size of the trade. We also show that public disclosure of trades in the first stage reveals the information contained in the trade and thus radically alters the structure of the market. We use our model to compare the competitive dealership market (with and without public disclosure) with the standard auction type market and to address some of the issues raised in the continuing public disclosure controversy at the London Stock Exchange