Market Structure

Financial asset markets deal with stocks, bonds, notes, mortgages, and other claims on real assets.

We can differentiate four types of markets: direct search markets, brokered markets, dealers markets, and auction markets.

A direct search market is the least organized market. Here, buyers and sellers must seek each other out directly. One example of a transaction taking place in such a market would be the sale of a used refrigerator in which the seller advertises for buyers in a local newspaper. Such markets are characterized by sporadic participation and low-priced and nonstandard goods. Its does not pay most people or firms to seek profits by specializing in such an environment.

The next level of organization is a brokered market. In markets where trading in a good is sufficiently active, brokers can find it profitable to offer search services to buyers and sellers. A good example is the real estate market.

When trading activity in a particular type of asset increases, dealer markets arise. Here, dealers specialize in various commodities, purchase assets for their own inventory, and sell goods for a profit from their inventory. Dealers, unlike brokers, trade assets for their own accounts. The dealer's profit margin is the "bid-asked" spread - the difference between the price at which the dealer buys for and sells from inventory. Dealer markets save traders on search costs because market participants can easily look up prices at which they can buy from or sell to dealers. Obviously, a fair amount of market activity is required before dealing in a market is an attractive source of income. The over-the-counter securities market is one example of a dealer market.

Physical asset markets (also called “tangible” or “real” asset markets) are these for such products as wheat, autos, real estate, computers, and machinery. Financial asset markets deal with stocks, bonds, notes, mortgages, and other claims on real assets.

Spot markets and futures markets are terms that refer to whether the assets are being bought or sold for “on the spot” delivery (literally, within a few days) or for delivery at some future date, such as six months or a year into the future.

Money markets are the markets for debt securities with maturities of less than one year. Capital markets are the markets for long-term debt and relatively riskier securities such as corporate stocks. For example, the New York Stock Exchange (NYSE) is a capital market or auction market.

The most integrated market is an auction market, in which all transactions in a good converge at one place to bid on or offer a good. An advantage of auction markets over dealer markets is that one need not search to find the best price for a good. If all participants converge, they can arrive at mutually agreeable prices and, thus, save the bid-asked spread.

Continuous auction markets (as opposed to periodic auctions such as inn the art world) require very heavy and frequent trading to cover the expense of maintaining the market. For this reason, the NYSE and other exchanges set up listing requirements, which limit the shares traded on the exchange to those of firms in which sufficient trading interest is likely to exist.

To organized stock exchanges are also secondary markets. They are organized for investors to trade existing securities among themselves.