Abstract: We provide a three way theoretical comparison of dealer, limit order, and hybrid markets and analyze the impact that the organization of trading has on volume, liquidity, and price efficiency. We find, in particular, that trading volume is highest in the limit order market and lowest in the dealer market. Small order price impacts are lowest and large order price impacts are highest in limit order markets. Prices are most efficient in the hybrid market and least efficient in the dealer market, except when the level of informed trading is very high. Post-trade market transparency in a hybrid market hampers price efficiency for thinly traded securities. We further identify that traders behave as contrarians.
Keywords: liquidity, quote and order driven markets, price efficiency, hybrid markets, trading volume
JEL Classification: D82; G10; G12; G14