Information Efficiency On The Over The Counter Market

The OTC market refers to trading venue outside exchange, which is organized by securities broker(dealer). With the rapid development of modern information technology and electronic trading technology, the traditional OTC market gradually grown from dispersedOTC market to aggregated OTC market, even network-based OTC market. From overseas experience, the OTC market trade not only non-standardized financial products, it even play a significant role in trading standardized financial products, constituting fierce competition to exchanges. In 2009 the Over the counter market takes 36% share of listed stock trading, through its various platforms such as ECN, Dark poll and inter-broker trading systems. With continuous development of China’s economy and reform progresses, the development of multi-level capital market is imperative. While China’s OTC market is still in its infancy, Compared with the exchanges, the Over- the- counter market is less liquid, disclose less information. In such information asymmetry, How to improvenformatione efficiency of the OTC market, which will be the basis of healthy development of China’s a multi-level capital marke.The aim of this article is to analyze the trading mechanism of the Over- the- Counter market, identifying the appropriate trading mechanism facilitating informationtransmission. Since the Over- the- counter market underlies capital markets, great attention has been paid to the development of its trading mechanisms, trading organizations and trading process, which are distinct from that of exchanges. Could information aggregation be possible in the overthe- counter market? Or if it possible, how to assess the magnitude and accuracy of information transmission? and how to measure its convergence rage to information aggregation.The current academic study of OTC market emphasis more on qualitative analysis, while the market microstructure research has almost exclusively focused on the exchange market. This paper is amid to bridge the lacking gap of research on information efficiency on the OTC market. My study aims to build a analytical framework to understand the regulation and organization of the OTC market, through re-conceptualizing the relationship among market frictions, marketorganization and regulations. Study objectives including:(1)Theoretical study on organization and regulation of OTC market, bringing previous scattered study into a comprehensive framework with historical and pragmatic perspectives;(2Market microstructure studies on the effect of changes of trading mechanims on efficincey of information aggregation? OTC financial innovations in the US, conducting factual investigation on innovation contexts, including technology advances, the changing nature of investors and broker dealers, and the increasingly complicated governance context of transactions, Against that background, assessing whether such products and corresponding regulations of the time to be appropriate;(3) Based on the evolution of OTC market in the US, providing policy suggestions for regulation and organization of the OTC market in China; In addition, based on field study of financial innovation in the US, identifying applicable products in China context.Main finding of this paper is the following:1、The OTC market represent trading platform of non-standardized financial products, as it stand for high financial risk, the OTC market bears naturedly information asymmetry. while information asymmetry will affect the ability of the market to display information, which in turn affects the efficiency of market allocation of resources, and thus solving the problem of information asymmetry in the OTC market is crucial;2、Information percolation in the OTC market is gradual. Private information in the OTC market will gradually revealed, but fully reveal only in rational expectations, and through Beythy study. Furthermore, information percolation in the OTC market is complex since it has multiple results ranging from information fully reveal to no reveal. Market efficiency is only one of results of information efficency.As a result, between the semi-strong efficient and strong efficient market, there are still many middle market effectively; thus to measure information efficiency of the OTC market, we could measure the degree and speed of efficiency in the OTC market3、Market microstructure affects the efficiency of the over the counter marke.Under different microstructures, multiple games plays in the OTC market, and may produce three types of balance: the separating equilibrium which fully reveal information; the quasi separating equilibrium which partly reveal information; and the combined equilibrium which cannot reveal information; the main factors affecting the efficiency of market including: trading mechanism to determine the time and manner of trading orders submitted; trade organization by affecting the trading strategy, and trading transparency which affected learning, thereby affecting the information revealing rate.4、The Over the counter market is an information system, by changing its market microstructure, and then change the information percolation, then changing market information efficiency. Trading rules of the game affects not only the ability and access of traders to information, but also trader’s game strategy, which will ultimately affect the market efficiency. Main influencing mechanisms include: setting market maker to gradual reveal private information; setting multilateral trading network, which reveal more information than single counter; setting non-public trading platform which reveal information faster than only setting public trading platform5、China should accelerate to develop laws and rules to improve efficiency of OTC market, through the construction of dealer market, institutional market and dark market. Main supporting laws including: the establishment of a limited regulatory philosophy,Promote self-discipline; the establishment of a market maker trading mechanisms; the establishment of qualified institutional investors; Further improve the non-public issuance of securities and trading system; encouraging product innovation in the OTC marketMain contributions of this paper including:1、Combining interdisciplinary perspective of information economics and institutional economics to analyze market efficiency of the OTC market. Through institutional economics perspective, this paper analyze the origin, development and function of orientation OTC market; Also this paper analyzemarket microstructure of the OTC market through information economics. The two disciplines converges to "Information percolation " on the OTC market, since the key problerm in OTC market is tosolve information percolation under asymmetric information, thus the external representaiton focused on developing trading system on OTC market, with intrinsic representaion focused on enhanceing market efficiency of OTC market.2、Extended Fama(1970) definition of market efficiency, measuring market efficiency through magnitude and speed of full information on OTC market. Introducing price variance to measure the degree of information to full reveal information; and after traders test of faith to measure the rate of convergence rate information reveal3、Establish information display model under the over the counter market; market maker adjust quotes dynamically to reveal the latest market information, λreflect quotes adjustment to full information reveal, the greaterλ, the larger the adjustment, the harder information revealing. Market maker mechanism construct information network in OTC market,while market efficiency is not only bound to trading mechanism, but also affected by trading strategy, and the impact of information distribution.;4、Establish unilateral-multilateral trading information display model in over the counter market, to measure and compare degree of information revealing under different trade organizations; Model shows multilateral trading network makes informed traders trade more competitive, thus private information reveals faster and more than in single trading counter. Empirical results confirms theoritical study that multilateral trading network improve market efficiency5、Establish public-non public information display model in over the counter market, to measure and compare information revealing speed different under different trade transparency. The model assumes information displayed in Poisson process, when the non-public and public information coexist, information reveal faster than only in public information channels. The economic implications is that information transparency has impact on information efficiency, thus establishing nonpublic trading platform on OTC market can improve market efficiency;6 、 Empirical test information efficiency under different market microstructur : information efficiency on multilateral counter trading network is not weaker than the exchange market;OTC market maker quotes plays a certain role, but not significant; Dispersed OTC market is in weak-form efficiency; therefore differences in trading system information will affects the efficiency of market information...