Procedural Fairness in Exchange Matching Systems

Abstract

The move from open outcry to electronic trading added another responsibility to futures exchanges—that of matching orders between buyers and sellers. Matching systems can affect the level and speed of price discovery, the distribution of revenue, as well as the level of price efficiency of a given market. Whether the matching system is procedurally fair is another important consideration. I argue that while FIFO (First In First Out) is a fair procedure in principle and is perceived as the default matching system, it is not a fair procedure in practice. Likewise, while pro rata is a fair procedure in principle, it is not so in practice. Nevertheless, both FIFO and pro rata are relics of an open outcry system. Instead, I propose an alternative approach to matching systems that builds on the strengths of electronic trading—the ability to randomize in real time. I introduce random selection for service (RSS) as a matching system that is procedurally fair both in principle and in practice.