Market composition and price informativeness in a large market with endogenous order types

We analyse the joint determination of price informativeness and the composition of the market by order type in a large asset market with dispersed information. The market microstructure is one in which informed traders may place market orders or full demand schedules and where market makers set the price. Market-order traders trade less aggressively on their information and thus reduce the informativeness of the price; in a full market-order market, price informativeness is bounded, whatever the quality of traders' information about the asset's dividend. When traders can choose their order type and demand schedules are (even marginally) costlier than market orders, then market-order traders overwhelm the market when the precision of private signals goes to infinity. This is because demand schedules are substitutes: at high levels of precision, a residual fraction of demand-schedule traders is sufficient to take the trading price close to traders' signals, while the latter are themselves well aligned with the dividend. Hence, the gain from trading conditional on the price (as demand-schedule traders do) in addition to one's own signal (as all informed traders do) vanishes.