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An auction market is a type of market where buyers and sellers enter competitive bids and offer at the same time, and the price of a trade is determined by the highest bid and the lowest offer that match. Because both buyers and sellers can add their prices to a list, the market is also referred to as a double auction market. If a match is made, the deal is then carried out.Â
Dealer markets, where buyers and sellers bargain with brokers or market makers who offer liquidity and benefit from the bid-ask spread, are different from auction markets. Dealer markets are where buyers and sellers bargain with brokers or market makers.
Auction markets have several advantages over other types of markets, such as:
The New York Stock Exchange (NYSE), where equities are electronically traded based on the supply and demand of buyers and sellers, is one of the most well-known examples of an auction market. The NYSE employs a system of specialists who are in charge of preserving a fair and orderly market for a particular stock. By posting bid and ask prices on an electronic board and completing trades when a match is made, specialists connect buyers and sellers. Specialists can interfere in the market to stabilize prices or address imbalances while simultaneously trading for their own interests.
The U.S. Treasury market, where government assets are issued and sold through auctions, is another illustration of an auction market. The U.S. Treasury regularly runs auctions for a variety of assets, including bills, notes, bonds, and TIPS that are inflation-protected. Large institutional investors and the general public are also welcome to participate in the auctions. They can electronically make their bids using the TreasuryDirect system or through primary dealers.Â
The bids are classified into competitive and noncompetitive bids, depending on whether the bidder specifies a price or accepts the prevailing market price. Competitive bids may receive less or none of the securities, depending on the supply and demand of the securities, but noncompetitive bidders are assured to obtain their desired quantity of shares, up to a maximum of $5 million.
Auction markets have several advantages over other types of markets, such as:
- Efficiency: Auction marketplaces make it easier to determine prices by compiling data from all buyers and sellers and reflecting an asset's genuine market value.
- Transparency: In order to eliminate information asymmetry and boost market confidence, auction markets provide transparent information about the prices, volumes, and participants of trades.
- Competition: Competition between buyers and sellers is encouraged via auction marketplaces, which lowers transaction costs and improves execution quality.
- Volatility: Due to shifts in supply and demand, auction markets, particularly in illiquid or thin markets, can undergo significant price variations.
- Manipulation: Auction markets are prone to manipulation by powerful or large traders, who can change trade prices or volumes by submitting false or deceptive bids or offers.
- Complexity: For new or unskilled traders who may not grasp the rules or procedures of the auctions, auction markets can be complicated and perplexing.
