S. Viswanathan
James J.D. Wang
Duke University, Durham, NC 27708
ABSTRACT
We analyze the choice between a limit-order book and a dealership market when market makers/limit-order providers compete by bidding for the order flow and the order flow is divisible. The analysis draws on the analogy between a limit-order book market and a discriminatory auction and that between a dealership market and a funiform-price auction. Main findings of the paper are as follows: (1) for sufficiently small order size variation, the customer will always choose a limit-order book market over a dealership market; (2) on an ex ante basis, a risk neutral customer prefers to trade in a limit-order market instead of a dealership setting; (3) on an ex ante basis, a risk averse customer prefers to trade in a dealership market when the number of market makers is large and when the order size variation is significant; and (4) in many cases, the customers' preference with respect to the choice of market structure is mirrored by the markets'.