Experience Stern | Faculty & Research

Recent financial market misconduct has cost firms record fines, lost reputation and prompted investigation and calls for curbing dissemination of order flow information. New research from NYU Stern Professor Laura Veldkamp and Nina Boyarchenko and David O. Lucca of the Federal Reserve Bank of New York, finds that information sharing in U.S. Treasury auctions raises auction revenues, as bidders are better informed. When information sharing enables collusion, the collusion initially costs revenue, but prohibiting information sharing costs more.
 
This new research reverses common wisdom that “Chinese walls” should be put in place to eliminate information sharing between dealers and customers in U.S. Treasury auctions.  Recent investigations reportedly involve U.S. Treasury auctions, but the use of order flow information, or “market color,” has been central to understanding Treasury auctions.
 
Using a calibrated model, the co-authors found:

• The primary beneficiary of information sharing is the U.S. Treasury, who benefits from the higher bids of better-informed buyers. Moving from full information sharing to a policy of no information would lower Treasury auction revenues by $4.8 billion annually, raising significant policy concerns.
• Inter-dealer information sharing makes beliefs more common and improves risk-sharing and welfare. Dealer information sharing with other dealers and clients have opposite effects on investor utility.
• If the dealers share enough information with clients, the initial revenue costs caused by information sharing and collusion may disappear.
• The combination of information sharing and intermediation choice amplifies the effect of negative news, making failed auctions more likely.

The working paper, “Taking Orders and Taking Notes: Dealer Information Sharing in Treasury Markets” is available in the August 1st NBER newsletter.