Journal of Financial Economics 55 (2000) 425}459 Can transparent markets survive?q

This paper investigates whether transparent markets can survive when faced with direct competition from less transparent markets. We "rst construct a game-theoretic model in which in equilibrium the low-transparency dealers capture early order #ow, and use the resulting informational advantage to quote narrower spreads and earn more pro"ts than their more transparent competitors. We then conduct a laboratory experi-ment that tests and supports all of these predictions. A second experiment shows that most dealers choose to be of lower transparency when they are allowed to do so. However, the informational advantage of low-transparency decreases as there are more such dealers, while the high-transparency dealers get increasing bene"t from informed traders who attempt to broadcast deceptive trades. As a result, a small number of transparent dealers persist in our markets. ( 2000 Elsevier Science S.A. All rights reserved