Why Do We Need a Secondary Market?

In secondary markets, investors exchange with each other rather than with the issuing entity. A perfect example is the stock market. If you buy a stock, you are doing so with another individual who already owns the stock, as opposed to buying it from the actual company whose stock it is. The latter would occur in a primary market through an initial public offering (IPO).

Secondary markets are an important facet of the economy. Through a massive series of independent yet interconnected trades, the secondary market steers the price of an asset toward its actual value through the natural workings of supply and demand. It is also an indicator of a nation's economic wellbeing. The increase or decrease in prices signals a growing economy or an economy heading towards a recession.

Secondary markets are most commonly linked to capital assets such as stocks and bonds.

Moreover, secondary markets create additional economic value by allowing more beneficial transactions to occur and create a fair value of an asset. Secondary markets also provide liquidity to the economy as sellers can sell quickly and easily due to a large number of buyers in the market.

The net result is that almost all market pricesinterest rates, debt, houses, and the values of businesses and entrepreneursare more efficiently allocated because of secondary market activity.

Economic Efficiency

Secondary markets are most commonly linked to capital assets such as stocks and bonds. It doesn't take much time to think of plenty of other secondary markets, however.

There is a secondary market for used cars. Consignment shops or clothing outlets such as Goodwill are secondary markets for clothing and accessories. Ticket scalpers offer secondary market trades, and eBay (EBAY) is a giant secondary market for all kinds of goods. Mortgages are also sold in the secondary market as they are packaged into securities by banks and sold to investors.

Secondary markets exist because the value of an asset changes in a market economy. These changes are driven by technology, individual tastes, depreciation and improvements, and countless other considerations.

Secondary market traders are, almost by definition, economically efficient. Every non-coercive sale of a good involves a seller who values the good less than the price and a buyer who values the good more than the price. Each party benefits from the exchange. Competition between buyers and sellers creates an environment where ask and bid prices meet at the buyers who value the goods most highly relative to demand.

Economic efficiency means that resources are driven to their most valued end. Secondary markets have historically reduced transaction costs, increased trading, and promoted better information in markets.

Secondary Capital Markets

The most renowned secondary markets have taken the form of physical locations, even if many secondary trades are now completed electronically from remote locations. The New York, London, and Hong Kong stock exchanges are among the most important and influential capital market hubs in the world. Today, however, these have largely moved to online or electronic venues.

Secondary markets promote safety and security in transactions since exchanges have an incentive to attract investors by limiting nefarious behavior under their watch. When capital markets are allocated more efficiently and safely, the entire economy benefits.

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