Liquidity, Trading Size, and the Co-existence of Dealership and Auction Markets

Abstract

This paper analyses the coexistence of two markets for the same shares, a quote-driven market and an order-driven market, as observed for example for the trading of continental shares on the London SEAQ International. The focus is on the trade-obetween the uncertain execution price faced by investors on an auction market and the implicit transaction cost repre- sented by the spread in a dealer market. We obtain that those investors who desire to make large trades will prefer to trade with the dealer, while trades of smaller size will be carried out on the auction market. Moreover, we explicitly investigate the interrelations between the two markets show- ing that the pricing policy followed by a dealer depends on the conditions prevailing on the auction market.