As of April 23, 2001, the limit order book for stocks listed on Euronext Paris became anonymous. We study the effect of this switch to anonymity on market liquidity and the informational content of the limit order book. Our empirical analysis is based on a model of limit order trading in which traders have information on future price volatility. As limit orders have option-like features, this information is valuable for limit order traders. We analyze limit order traders' bidding strategies in 2 different market structures : (a) an anonymous market (limit order traders' IDs are concealed) and (b) a non-anonymous market (traders' IDs are disclosed). Limit order traders bid less aggressively when they expect volatility to rise. For this reason, in either market design, an increase in the bid-ask spread foreshadows increased volatility. Moreover, when information on future volatility is public, the informational content of the bid-ask spread and market liquidity are identical in each market structure. In contrast, when some traders possess superior information on future volatility, a switch to anonymity alters the informational content of the bid-ask spread and market liquidity. For our sample stocks, we find that the switch to anonymity in Euronext paris has significantly reduced the average quoted spread and the average effective spread. We also find that the size of the bid-ask spread is positively related the magnitude of future price movements. But the strength of this association is weaker after the switch to anonymity. Overall, the empirical findings are consistent with the version of our model in which traders possess private information about future volatility.
Market Microstructure Limit Order Trading Anonymity Transparency Liquidity Volatility Forecasts