The Informational Role of Prices: A Review Essay

The last three or four years have seen an explosion in the literature on
asset markets with asymmetric information and especially on trading mecha-
nisms, an area called the ‘microstructure of financial markets’. There are a
number of reasons for this development. First, following the crash of 1987
and, more generally, given the increasing complexity of the trading environ-
ment, many policy issues related to the organization of financial markets have
become important. Examples of such issues include the interaction between
different exchanges where the same or very closely related securities are
traded, the role of designated market makers, the desirable degree of
competition among market makers, the type of information which should be
communicated during the trading process to various participants (e.g., what
information about the trading process should become public and when, how
should communication between market makers and different exchanges be
structured), and so on. A number of reports issued after the stock market
crash have emphasized the need to study the details of the trading process.