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Auction Markets, Dealership Markets and Execution Risk


  • Marco Pagano
  • Ailsa Roell


Dealers are suppliers of liquidity; in this respect their role is similar to that played by speculators in auction markets. However, dealers are a special kind of speculator, because of the many obligations and privileges conferred upon them. The most obvious constraint on dealers' behaviour is their obligation to quote firm prices publicly; this implies that, in contrast with what happens on auction markets, traders are insured against execution risk, i.e., the risk of finding few or no counterparty to trade. The normative issue then is: when is it efficient for customers to buy insurance from dealers rather than bearing execution risk themselves? In our model the relevant condition is that dealers must be sufficiently less risk-averse than their customers. The dealership market is superior if dealers are risk-neutral and customers are risk- averse, while it is dominated by the auction market if dealers have the same degree of risk aversion as their customers. There is also an intermediate region of parameter values where the comparison between the two systems is ambiguous: if the fundamental risk of the security is low, the dealership mechanism dominates the auction, while for high-risk securities the reverse is true.

Suggested Citation

  • Marco Pagano & Ailsa Roell, 1990. "Auction Markets, Dealership Markets and Execution Risk," CEPR Financial Markets Paper 0008, European Science Foundation Network in Financial Markets, c/o C.E.P.R, 77 Bastwick Street, London EC1V 3PZ..
  • Handle: RePEc:cpr:ceprfm:0008

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    References listed on IDEAS

    1. Avner Shaked & John Sutton, 1982. "Relaxing Price Competition Through Product Differentiation," Review of Economic Studies, Oxford University Press, vol. 49(1), pages 3-13.
    2. Douglas W. Diamond, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Oxford University Press, vol. 51(3), pages 393-414.
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    Cited by:

    1. Goodhart, Charles A. E. & O'Hara, Maureen, 1997. "High frequency data in financial markets: Issues and applications," Journal of Empirical Finance, Elsevier, vol. 4(2-3), pages 73-114, June.
    2. Victoria Saporta, 1997. "Which Inter-dealer Market Prevails? An analysis of inter-dealer trading in opaque markets," Bank of England working papers 59, Bank of England.
    3. Marco Pagano, 1998. "The Changing Microstructure of European Equity Markets," CSEF Working Papers 04, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
    4. Oehler, Andreas & Unser, Matthias, 1998. "Market Transparency and Call Markets," Discussion Papers 6, University of Bamberg, Chair of Finance.
    5. Karl F Habermeier & Andrei A Kirilenko, 2001. "Securities Transaction Taxes and Financial Markets," IMF Working Papers 01/51, International Monetary Fund.


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