Strategic Uncertainty in Financial Markets: Evidence from a Consensus Pricing Service

Many over-the-counter markets suffer from a lack of publicly available price data. This creates problems for two market activities. The first activity is trading: prices are an important source of information when valuing assets. The second is managing risk: public prices provide a reference point for market participants to have a common understanding of market conditions. This is a key input for reducing uncertainty about relative positions among participants, known as strategic uncertainty.

As a market response to these problems, consensus pricing services have sprung up in many over-the-counter markets. These services collect and average price estimates from market participants. In this paper, we analyze a consensus pricing service that operates in the over-the-counter options market. We measure valuation and strategic uncertainties among its participants (large dealer banks) and quantify the effect of the consensus price information on these uncertainties.

We find that the valuation and strategic uncertainty of dealer banks vary greatly across the different segments of the options market. Uncertainty is higher for option contracts that are not listed on centralized exchanges and are traded exclusively over the counter. We find that the consensus price information is most important for reducing strategic uncertainty, rather than valuation uncertainty. The effect is strongest in the most opaque segments of the options market. This finding stresses that publicly observed market data, such as financial benchmarks, are important to establish a shared understanding of conditions in markets with limited price transparency.