An Introduction to the Microstructure of Emerging Markets by Jack D. Glen

By Jack D. Glen

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In a dealer market, one or more individuals are responsible for providing quotes at which they are willing to buy or sell a security. Dealer quotes determine the price at which transactions occur. S. NASDAQ (over-the-counter) exchange is an example of an (electronic) dealer system. By contrast, in order-book systems traders place their quotes in (manual or electronic) order books, and then arriving orders are matched and transacted. Investor orders determine the prices at which transactions occur in order-book systems.

For example, liquid markets have lower transaction costs, especially bid/ask spreads and, as a result, the observed sequence of trading prices will be less volatile as the natural bouncing of transactions between the bid and ask occurs over time. Similarly, in an efficient market, new information will be correctly and quickly incorporated into price and even though that may entail price jumps, price overshooting and deviations from the equilibrium price are reduced in efficient markets. Thus, holding all else constant, liquid and efficient markets will be less volatile than illiquid and inefficient markets.

S. NASDAQ (over-the-counter) exchange is an example of an (electronic) dealer system. By contrast, in order-book systems traders place their quotes in (manual or electronic) order books, and then arriving orders are matched and transacted. Investor orders determine the prices at which transactions occur in order-book systems. The Tokyo Stock Exchange is an example of an order-book system. The New York Stock Exchange is a hybrid system, with market specialists who both make the market and process a public order book.

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