Additional Resources

  1. Limiting Trade: Economics Lesson [ecedweb.unomaha.edu]
  2. Markets: Exchange Or Over-the-counter [0-imf.org.library.svsu.edu]
  3. Trade, At What Price? [webfeeds.brookings.edu]
  4. Pre-trade Transparency In Over-the-counter Markets [ou.edu]
  5. Monetary Exchange In Over-the-counter Markets [economics.ucdavis.edu]
  6. Family Tree Of Trade Economists 2.0 [www-personal.umich.edu]

Definition

Over-the-counter or off-exchange trading is done directly between two parties, without any supervision of an exchange. It is contrasted with exchange trading, which occurs via exchanges. A stock exchange has the benefit of facilitating liquidity, mitigates all credit risk concerning the default of one party in the transaction, provides transparency, and maintains the current market price. In an OTC trade, the price is not necessarily published for the public.

Over the Counter Trading

Any security that is traded anywhere, other than a formal exchange such as PSX, NASDAQ, Nikkie etc, is referred to as an OTC (Over-The-Counter) Trade or an Off Exchange Trade.

Bilateral Trade

Typically such trade is bilateral since it takes place between two individuals or organizations without the support or supervision of a stock exchange. This is because quite unlike a formal (Stock) exchange, OTC trading is never centered on a specific place or location.

Nevertheless, OTC trade just like its Stock Exchange counterpart deals with the buying and selling of financial instruments (such as stocks of PL companies), commodities as well as derivatives of all similar products.

The OTC market does not suffer from the limitations of the Stock exchange such as standardized product trading, and a markedly narrow range of financial deliverables whose quantity and identity has been pre-determined by the exchange for transparency related reasons. The two parties undertaking the OTC trade may for example agree on a very high quantity that would be above the limits of the conventional Stock exchange. However, the associated risks corresponding to such a trade are far higher than trading at a physical exchange governed by its own specific set of laws, rules and regulations.

Less formal but more organized

OTC traders while being a lot less formal than its exchange counterpart, is still pretty well organized. Many dealers have their own networks of trading relationships and customers who prefer to deal with them rather than the exchange.

Sole responsibility of the traders

A crucial aspect of OTC trading is that settlements and clearing of all trading activity is the sole providence of the buyer and the seller, whereas in exchange transactions, the actual trades are guaranteed by the exchange by default, thereby decreasing the risks incurred.

Interdealer market

Another characteristic of OTC trading is the Interdealer market where dealers both quote and bid prices to each other and in this way lower their total risks by involving other dealers to their sales. They can also simply call each other to get multiple quotes and are able to price their product accordingly. A lay customer on the other hand would have to rely on his specific dealer for a quote since it is unlikely that other dealers would be willing to divulge information to relative strangers.

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