Market design, trading decisions, price formation, and liquidity with asymmetric information

Markets for financial assets are not only the places where traders buy and sell to achieve desired portfolio positions or to profit from arbitrage strategies, but also the places where information is gathered, processed, and incorporated into prices. Changes in the design of markets and the design of the securities traded directly affect the trading decisions of market participants. Given that investors are asymmetrically informed, the changes in individuals' behavior combine and interact to result in a new equilibrium state of price formation, price efficiency, and liquidity. Those are characteristics of the market environment that are important to investors. Also, the proliferation of new exchanges and markets provides the opportunity to create more desirable markets and trading venues, and to modify certain feature of the trading system to better meet investor needs. Therefore, studies on the costs and benefits of changes in market design are not just interesting to academics, but also have immediate policy implications. The three essays of my dissertation contribute to this literature by addressing the basic questions that in financial markets with asymmetrically informed investors, what are the impacts of changes in market design on trading decisions of market participants, and on the equilibrium price formation process and market liquidity?; Market design includes a wide range of features. The first two essays focus on two of the important changes. Essay one examines the effects of an increase in pre-trade transparency, which is the ability of market participants to observe information about quotes and trading interest. Essay two investigates the role of new markets for basket securities, which is essentially portfolios of existing securities traded as one. Despite the differences in the designs of the empirical analyses, both papers focus on the same basic question. The analyses and arguments in the first two essays rely on the assumption of information asymmetry. How do we measure information asymmetry? Essay three investigates whether permanent price impact measures describing intra-day price movements are helpful in characterizing information asymmetry about the fundamentals of firms. (Abstract shortened by UMI.)...