Pro-rata matching

Pro-rata matching comes in a variety of flavors and is usually implemented in slightly different ways. For the scope of this book, we provide some intuition behind this matching algorithm and provide a hypothetical matching scenario.

The underlying intuition between pro-rata matching is that it favors larger orders over smaller orders at the same price and ignores the time at which the orders were entered. This changes the market's microstructure quite a bit, and the participants are favored to enter larger orders to gain priority instead of entering orders as fast as possible:

BIDS

ASKS

Order A: Buy 100 @ 10.00

Order X: Sell 100 @ 11.00

Order B: Buy 200 @ 10.00

Order Y: Sell 200 @ 11.00

Order C: Buy 700 @ 10.00

Order Z: Sell 200 @ 12.00

Order D: Buy 100 @ 9.00

Consider a market state as shown earlier. For the sake of this example, the hypothetical order sizes have been raised by a factor of 100. Here, bid orders A, B, and C are at the same price, 10.00. However, when an incoming sell order of size 100 comes in for price 10.00, order C gets a fill for 70 contracts, order B gets a fill for 20 contracts, and order A gets a fill for 10 contracts, proportional to how big they are at that level. This is an overly simplified example that excludes complications related to fractional match sizes and breaking ties between orders with the same size, and so on. Also, some exchanges have a mix of pro-rata and FIFO, where part of the incoming aggressor matches using pro-rata, and part matches in FIFO order. But this should serve as a good basic understanding of how different pro-rata matching is compared to FIFO matching. A detailed examination of pro-rata matching and its impact is beyond the scope of this book, so we exclude it.

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