Pre-Trade Opacity, Informed Trading, and Market Quality

We investigate exchange-based hidden orders from an information perspective. Using order flow data that categorizes each order submitter into one of many institutional and non-institutional categories, we test several hypotheses and document substantial evidence on a spectrum of issues in this context. First, institutional investors (both domestic and foreign) submit more hidden orders than non-institutional investors. Second, the contribution of hidden orders to overall price discovery is significantly greater than that of non-hidden orders. Third, traders with higher information levels are significantly more likely to hide a larger proportion of trades. Fourth, informed traders are significantly more likely to submit hidden orders than uninformed traders. Fifth, informed trader categories that submit hidden orders make significantly greater economic profits than those that do not; while, in contrast, uninformed trader categories make significantly lower economic profits when they submit hidden orders than when do not hide their orders. Finally, relative to other periods, informed trader categories submit more hidden orders in the five days before and after earnings announcements (an exogenous information-intensive period), while the uninformed trader categories do not change their hidden order submission strategies around earnings announcements. Overall, we present overwhelming evidence linking informed traders with the propensity for pre-trade opacity.