Quote-Driven Market: What It Means and How It Works

Definition

A quote-driven market (also called a price-driven or dealer market) is a trading system where prices are set by market makers, dealers, or specialists who post bid and ask quotations. Traders transact by accepting those quotes or negotiating with dealers, who fill orders from their own inventory or by matching them with other orders.

How it works

• Dealers post bid (buy) and ask (sell) prices for securities.
• Customers trade directly with dealers at quoted prices or seek negotiated terms via brokers.
• Dealers may trade among themselves through inter-dealer brokers.
• Dealers supply the market’s liquidity by buying or selling from their inventories.

Dealers are not obligated to execute trades for every client; they may specialize in certain instruments or client types (e.g., retail vs. institutional) and can decline trades that fall outside their focus.

Where it’s used

Quote-driven systems are common in markets for:
* Bonds
* Currencies (foreign exchange)
* Commodities

Stock exchanges are often hybrid, combining quote-driven and order-driven elements.

Quote-driven vs. Order-driven markets

Order-driven markets
* Display individual buy and sell orders, including prices and quantities.
* Provide greater transparency because market depth and individual orders are visible.
* Execution depends on matching existing orders; there is no guaranteed fill.

Quote-driven markets
* Rely on dealers to provide continuous bid/ask quotes.
* Generally offer greater liquidity because dealers commit capital to facilitate trades.
* Less transparent since many quotes come from dealers rather than visible public orders.
* Dealers are typically required to honor their quoted prices, increasing certainty of execution.

Hybrid markets

Exchanges like the NYSE and Nasdaq blend both systems: visible order books alongside market makers or specialists who post quotes and help maintain liquidity.

Advantages and disadvantages

Advantages:
* Enhanced liquidity due to dealer participation.
* More reliable execution when dealers are obligated to honor quotes.
* Useful for less liquid instruments where public order flow is thin.

Disadvantages:
* Reduced transparency compared with order-driven markets.
* Potential for wider spreads or quote variability if dealer competition is limited.
* Dependence on dealers’ willingness to hold inventory and make markets.

Key takeaways

• Quote-driven markets place price-setting responsibility on dealers and market makers.
• They are well suited to bond, currency, and commodity trading, and improve liquidity through dealer inventories.
• Order-driven markets expose individual orders and offer transparency but may have less guaranteed execution.
• Many modern exchanges operate as hybrids, combining the strengths of both approaches.