Pre-trade transparency and market quality

There is no consensus in the literature on whether an increase in pre-trade transparency results in an improvement or deterioration in market quality. Two discrete changes in pre-trade transparency on the Korea Exchange (KRX), an electronic order-driven market, allow us to address this question. We find that market quality is increasing and concave in pre-trade transparency, with significantly diminishing returns above a certain point. We argue that previous event studies of the effect of transparency have been econometrically flawed, propose a procedure to correct this flaw, and show that this procedure can reverse the result of an event study.