What Is Price Transparency?
- Price transparency reflects the extent to which price and market information, such as bid-ask spread and depth, exist for a security.
- In standard economic theory, market participants all have perfect information and therefore price transparency is complete.
- In reality, prices are not fully transparent to all market participants, with some real-time quotes and liquidity measures only available for a fee from exchanges.
- Markets with greater price transparency are considered to be "freer" markets with lower information costs.
Understanding Price Transparency
Price transparency is important because knowing what others are bidding, asking, and trading can help determine the supply and demand of a security, good, or service, i.e., its true value. If the information proves to be insufficient or inaccessible, that specific market may be deemed inefficient.
The Nasdaq level II quote system, for example, provides information on all the bids and asks at various price levels for a particular stock. On the other hand, standard New York Stock Exchange (NYSE) quotes are less transparent, displaying only the highest bid and lowest ask prices. In that scenario, only the market specialists know the complete order flow for a stock. Price transparency can be contrasted with opacity.
At its core, market efficiency measures the availability of market information that provides the maximum amount of opportunities to purchasers and sellers of securities to effect transactions without increasing transaction costs.
The Sarbanes-Oxley (SOX) Act of 2002, for example, required greater financial transparency for publicly traded companies. It helped show that credible financial statements could generate more confidence in the stated price of a security.
With fewer surprises in financial statements, market reactions to earnings reports are smaller.
Price Transparency and Costs
In economics, a market’s transparency is determined by how much is known about its products and services and the capital assets that are available, as well as the pricing structure, and where they can be found. The degree to which that market is free and how efficient it is can be determined by its transparency.
Elsewhere in the economy, the level of price transparency can promote or depress competition. In healthcare, for example, patients often don't know what a specific medical procedure actually costs, leaving them without much, if any, opportunity to negotiate a better price.
Price transparency does not necessarily mean that prices will drop. Higher prices can result if sellers become reluctant to offer to certain buyers. Price transparency can also make it easier for collusion, or a non-competitive clandestine or sometimes illegal agreement between rivals that attempts to disrupt the market’s equilibrium. Price volatility, or the rate at which a security, good, or service increases or decreases, could be a byproduct of transparency as well.
A high degree of market transparency can also result in disintermediation or the removal or reduction in the use of intermediaries between producers and consumers; for example, by investing directly in the securities market rather than through a bank.
Insider trading is a manner in which price transparency is reduced as only certain market participants have information that they should not have, putting them at an advantage when compared to those who do not hold the same information. This also leads to pricing inefficiencies in the market.
Improvement of Price Transparency
The internet has greatly allowed for the improvement of price transparency. All types of information are readily available to individuals through a few clicks on their computer. In this manner, individuals can compare house prices in different markets to arrive at the true price of a home, for example. People shopping for products online can see where these products were made, how they were made, and compare the quality with other products, to end up with the best deal.
Electronic trading has greatly improved the efficiency of financial markets, allowing investors and traders to make faster decisions and capture real-time prices. This has also allowed investors to save on money because they no longer need to use brokers and pay them commission because they can purchase assets themselves.
The way in which individuals can obtain accurate information through the internet has greatly altered most industries and made the buying process for all sorts of assets and items easier and more transparent for society.