What Is Price Transparency?
For example, the Nasdaq level II quote system provides information on all the bids and asks at various price levels for a particular stock. On the other hand, standard 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.
- Price transparency reflects the extent to which price and market information, such as bid-ask spread and depth, exist for a security.
- In standard economics, 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 quote 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.
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.
For example, the Sarbanes-Oxley Act of 2002 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, 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. How transparent that market is helps determine the degree to which that market is free and its relative efficiency.
Elsewhere in the economy, the level of price transparency can promote or depress competition. For example, in health care, patients often do not 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 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.