Kybernetika 53 no. 5, 922-958, 2017

Dynamic model of market with uninformed market maker

Martin Šmíd and Miloš KopaDOI: 10.14736/kyb-2017-5-0922

Abstract:

We model a market with multiple liquidity takers and a single market maker maximizing his discounted consumption while keeping a prescribed probability of bankruptcy. We show that, given this setting, spread and price bias (a difference between the midpoint- and the expected fair price) depend solely on the MM's inventory and his uncertainty concerning the fair price. Tested on ten-second data from ten US electronic markets, our model gives significant results with the price bias decreasing in the inventory and increasing in the uncertainty and with the spread mostly increasing in the uncertainty.

Keywords:

optimal decision, dynamic model, market maker, price and inventory, high frequency data

Classification:

91G80, 62P05

paper.pdf

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