Trading Mechanisms in Securities Markets



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    • From the University of Pennsylvania. This paper is based on Chapter II of my dissertation from Cornell University. I thank Franklin Allen, Marshall Blume, David Easley, Margaret Forster, Thomas George, Lawrence Glosten, Mark Grinblatt, Robert Jarrow, Nicholas Kiefer, Robert Masson, Maureen O'Hara, Seymour Smidt, René Stulz (editor), and the anonymous referee for their valuable suggestions. Seminar participants at Carnegie-Mellon University, Cornell University, New York University, the University of California Santa Barbara, the University of North Carolina, the University of Pennsylvania, the University of Pittsburgh, the University of Southern California, Vanderbilt University, the Econometric Society Meetings, and the Berkeley Program in Finance provided many helpful comments. Support from the Geewax-Terker Research Fund is gratefully acknowledged.


This paper analyzes price formation under two trading mechanisms: a continuous quote-driven system where dealers post prices before order submission and an order-driven system where traders submit orders before prices are determined. The order-driven system operates either as a continuous auction, with immediate order execution, or as a periodic auction, where orders are stored for simultaneous execution. With free entry into market making, the continuous systems are equivalent. While a periodic auction offers greater price efficiency and can function where continuous mechanisms fail, traders must sacrifice continuity and bear higher information costs.