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Quote Driven Market Simulation
(excerpted from Chapter 5, Market Intermediaries: Nuts 'n' Bolts and Challenges, in Robert A. Schwartz, Reto Francioni and Bruce W. Weber, The Equity Trader Course, John Wiley & Sons, 2006)

"Intermediation" means the participation of a third party in trading. Intermediaries include brokers, dealers, market makers, and specialists. A broker handles a customer order as the customer's agent. In contrast, a dealer is a principle who commits capital to a trade, buying from public sellers and selling to public buyers. A market maker is a dealer with special obligations to make a good, orderly market by running his or her own book and taking the corresponding risk. Currently, dealers in the equity markets are widely referred to as "market makers." We use the two terms interchangeably. A specialist is an intermediary on the US exchanges who operates as both a broker (agent) and dealer (market maker). Each stock listed on the NYSE is assigned to one specialist firm that has an affirmative obligation to make a fair and orderly market for that stock.

A market maker realizes revenue from the spread between his or her bid and offer quotes. With a larger spread, more revenue can be realized from a given volume (turnover). On the other hand, for a given spread, revenues are higher the greater is the trading volume (turnover) in a stock. With a highly liquid stock, a market maker profits mainly from volume, not from his or her spread being large.



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