A quote-driven market is a financial market where market makers provide continuous price quotes for buying and selling securities, facilitating liquidity especially for less liquid assets.
A quote-driven market, also known as a dealer market, is a trading environment where transactions are primarily facilitated by market makers or dealers who continuously provide bid and ask prices for securities. These market makers stand ready to buy and sell at these quoted prices, ensuring that there is a price available for investors at most times. This type of market is in contrast to order-driven markets where buyers and sellers enter orders that are matched directly. Quote-driven markets often handle securities that are less liquid or not listed on formal exchanges, such as corporate bonds or over-the-counter stocks. The market maker's quotes reflect their inventory, risk exposure, and the demand-supply balance, serving an essential function by providing liquidity and price discovery in these less transparent markets. These markets may vary in transparency and regulatory oversight, depending on the asset class and jurisdiction.
Understanding quote-driven markets is crucial when managing alternative or less liquid assets within a portfolio, as pricing and liquidity dynamics differ from exchange-traded securities. Market makers’ quoted prices can be wider due to the risks of holding inventory and less trading volume, impacting valuation and execution costs. This affects investment strategy by influencing timing and sizing of trades, and it requires careful consideration in portfolio liquidity management and risk assessment. From a tax planning and reporting perspective, the less transparent pricing in quote-driven markets may challenge the determination of fair market value, necessitating robust valuation methodologies and compliance procedures. Governance processes must ensure that risks associated with liquidity and price variability in quote-driven markets are properly understood and managed within the investment committee’s framework.
Consider a corporate bond trade in a quote-driven market where a market maker quotes a bid price of 98.50 and an ask price of 99.00. An investor looking to buy the bond will pay up to 99.00 per $100 of face value, while a seller will receive 98.50 if selling immediately. The market maker facilitates this trade by holding an inventory of bonds and managing risk between buying and selling, providing liquidity even if there is no immediate counterparty in the market.
Order-Driven Market
An order-driven market matches buy and sell orders directly, relying on supply and demand without intermediary market makers, typically seen in stock exchanges with transparent order books.
What distinguishes a quote-driven market from an order-driven market?
In a quote-driven market, dealers or market makers continuously provide bid and ask prices and stand ready to trade, whereas an order-driven market matches buy and sell orders directly between participants without intermediaries.
Are quote-driven markets less transparent than exchange-traded markets?
Generally, yes. Quote-driven markets often involve less public disclosure of quotes and trades compared to exchange-traded order-driven markets, making pricing and liquidity information less transparent.
How does trading in a quote-driven market impact portfolio liquidity?
Trading in quote-driven markets can involve wider bid-ask spreads and less frequent trading, potentially increasing transaction costs and affecting the ease of exiting positions, thus requiring careful liquidity management.
