Trading Mechanisms in Securities Markets

Abstract

This paper analyzes price formation under two trading mechanisms: a continuousquote-drivensystem where dealers post prices before order submission and anorder-drivensystem where traders submit orders before prices are determined. The order-driven system operates either as acontinuous auction, with immediate order execution, or as aperiodic 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.