Market Microstructure in Emerging and Developed Markets

CHAPTER 8

Market Architecture

A Conceptual Framework and Real-World Systems

MASSIMILIANO MARZO

Associate Professor of Economics, University of Bologna

INTRODUCTION

The increasing degree of sophistication in financial markets creates an urgent need to understand the logic underlying market architecture and the evolution of market structure through time. The goal of this chapter is to present an overview of recent institutional changes, as well as theoretical advances characterizing the recent history of advanced markets.

Historically, market evolution has closely followed technical advances. The recent speed of computing power and the need to lower transaction costs have caused important changes in market structure and market architecture. Recent advances in market architecture are characterized by fragmentation and nondisplayed exchanges such as dark pools.

Market architecture is directly determined by the characteristics of trading protocols (i.e., the set of rules classifying the order execution and how trading sessions are organized). In general, markets are structured according to two fundamental mechanisms: order-driven or quote-driven. Order-driven markets leave more room to direct interactions between agents operating in the market. In quote-driven markets, orders are handled by intermediaries. The market is called as hybrid when both systems coexist within the same market structure. Today, most financial markets in the world operate according to a hybrid protocol. This ...