Discrete pricing and the design of dealership markets

This paper incorporates institutional features of trading markets including the discrete nature of the price grid and determines the consequences for prices and strategic behavior. Interactions between market makers is complex: because equi librium prices are not determined by a zero-expected-profits condition, priority rules and the timing of offers have significant effects on equilibrium outcomes. Discreteness effectively limits competition and permits market makers to offer profitable quotes. When traders first submit orders, absolute time priority leads to the ''best'' price schedule, one which is ''better'' than that obtained From quote-driven institutions where market makers submit price schedules first. (C) 1996 Academic Press, Inc.