ABSTRACT
The classic microstructure literature distinguishes liquidity suppliers and liquidity demanders, which naturally introduces information asymmetry.That is, liquidity suppliers trade against potentially privately informed liquidity demanders and charge them an increased price concession to protect themselves.1 This deters uninformed, hedging-motivated liquidity demand and, in the extreme, might cause the market to break down. Information asymmetry thus reduces welfare (cf. Biais, Hillion and Spatt 2005, pp. 223-227). Easley, Hvidkjaer and O’Hara (2002) provide evidence that asymmetric information risk is priced, as stocks for which they estimate a high probability of informed trading have to offer higher expected returns.
