Quote-driven, Order-driven, and Brokered Markets

Quote-Driven Markets/Over-the-Counter (OTC) Markets

In quote-driven markets, customers trade at prices quoted by dealers who generally work for commercial banks, investment banks, broker-dealers, or trading houses. Most trades in these markets are conducted through proprietary computer communications networks or by phone.

Order-Driven Markets

Order-driven markets arrange trades using rules to match buy orders to sell orders submitted by customers or dealers. Almost all exchanges use order-driven trading systems, and every automated trading system is an order-driven system. Two sets of rules characterize order-driven market mechanisms: order matching rules, which match buy and sell orders, and trade pricing rules, which determine the price of the matched trades.

Order Matching Rules

Order-driven trading systems arrange buy and sell orders by price and sometimes other criteria. They try to match the top-ranked orders when possible and meet the minimum order size. If any portion of a buy or sell order remains unmatched, it will be paired with the next-ranked order. The main rule is to give priority based on the price, and there are secondary rules for orders at the same price. Generally, the first order to arrive at the best price gets priority, but in some cases, visible quantities are traded before hidden ones at the same price.

Trade Pricing Rules

Call markets often employ the uniform pricing rule, making all trades happen at the same price. The market picks a price that allows the most trading. In continuous trading markets, the discriminatory pricing rule is used. This rule sets the price according to the limit price of the first standing order. Crossing networks, which pair buyers and sellers using prices from other markets, use the derivative pricing rule. Typically, this means using the midpoint between the best bid and ask quotes for the underlying asset.

Brokered Market

Brokers match their clients’ trades for rare and illiquid instruments, as these wouldn’t attract many orders in traditional markets. This market involves a small number of individuals or institutions making trades.

Question

What market would an art collector use to sell a number of valuable paintings?

1. Brokered market.
2. Order-driven market.
3. Quote-driven market.

Solution

The correct answer is A.

Since there would not be enough liquidity for unique art pieces to have a quote-driven or order-driven market, the paintings would need to be sold in a brokered market.