INVENTORY HEDGING AND OPTION MARKET MAKING

2004 ◽  
Vol 07 (07) ◽  
pp. 853-878 ◽  
Author(s):  
ANTOINE GIANNETTI ◽  
RUI ZHONG ◽  
LIXIN WU
Keyword(s):  
Price Level ◽  
Supply And Demand ◽  
Market Maker ◽  
Price Setting ◽  
Market Making ◽  
Exercise Price ◽  
Reduce Risk ◽  
Theoretical Condition ◽  
Familiar Result ◽  
Option Market

In this paper, we develop an inventory-based approach to analyze the option market making activity. Indeed, we formulate and analytically solve the price-setting problem of a monopolistic option market maker facing exogenous public supply and demand first on a single exercise price (the "single option economy") and next on multiple exercise prices (the "multi-options economy"). While in the "single option economy" the familiar result that market maker inventory and price level are inversely related holds, the same is not necessarily true in the "multi-options economy". Additionally, we examine under which theoretical condition hedging is totally effective (i.e., the variance of the market maker hedged position is zero). Last but not least, our model is fully consistent with actual option market making practices, which consist in trading hedge portfolios to reduce risk. As such, our approach can be considered as a bridge between market microstructure and standard option pricing literature.

Market Making by Price-Setting Firms

1996 ◽  
Vol 63 (4) ◽  
pp. 559-580 ◽  
Author(s):  
D. F. Spulber
Keyword(s):  
Price Setting ◽  
Market Making

scholarly journals MARKET MAKING WITH ALPHA SIGNALS

2020 ◽  
Vol 23 (03) ◽  
pp. 2050016
Author(s):  
ÁLVARO CARTEA ◽  
YIXUAN WANG
Keyword(s):  
High Frequency ◽  
High Frequency Data ◽  
Model Parameters ◽  
Market Maker ◽  
Electronic Market ◽  
Market Making ◽  
Liquidity Provision ◽  
Limit Orders ◽  
Adverse Selection Costs ◽  
Downward Pressure

We show how a market maker employs information about the momentum in the price of the asset (i.e. alpha signal) to make decisions in their liquidity provision strategy in an order-driven electronic market. The momentum in the midprice of the asset depends on the execution of liquidity taking orders and the arrival of news. Buy market orders (MOs) exert a short-lived upward pressure on the midprice, whereas sell MOs exert a short-lived downward pressure on the midprice. We employ Nasdaq high-frequency data to estimate model parameters and to illustrate the performance of the market making strategy. The market maker employs the alpha signal to minimise adverse selection costs, execute directional trades in anticipation of price changes, and to manage inventory risk. As the market maker increases their tolerance to inventory risk, the expected profits that stem from the alpha signal increase because the strategy employs more speculative MOs and performs more roundtrip trades with limit orders.

scholarly journals Option market making under inventory risk

2009 ◽  
Vol 12 (1) ◽  
pp. 55-79 ◽  
Author(s):  
Sasha Stoikov ◽  
Mehmet Sağlam
Keyword(s):  
Market Making ◽  
Option Market

scholarly journals Welfare Effects of Market Making in Continuous Double Auctions

2017 ◽  
Vol 59 ◽  
pp. 613-650 ◽  
Author(s):  
Elaine Wah ◽  
Mason Wright ◽  
Michael P. Wellman
Keyword(s):  
Allocative Efficiency ◽  
Market Model ◽  
Model Parameters ◽  
Market Maker ◽  
Market Making ◽  
Market Makers ◽  
Continuous Double Auctions ◽  
Thin Markets ◽  
Heuristic Strategies ◽  
Fundamental Value

We investigate the effects of market making on market performance, focusing on allocative efficiency as well as gains from trade accrued by background traders. We employ empirical simulation-based methods to evaluate heuristic strategies for market makers as well as background investors in a variety of complex trading environments. Our market model incorporates private and common valuation elements, with dynamic fundamental value and asymmetric information. In this context, we compare the surplus achieved by background traders in strategic equilibrium, with and without a market maker. Our findings indicate that the presence of the market maker strongly tends to increase total welfare across various environments. Market-maker profit may or may not exceed the welfare gain, thus the effect on background-investor surplus is ambiguous. We find that market making tends to benefit investors in relatively thin markets, and situations where background traders are impatient, due to limited trading opportunities. The presence of additional market makers increases these benefits, as competition drives the market makers to provide liquidity at lower price spreads. A thorough sensitivity analysis indicates that these results are robust to reasonable changes in model parameters.

Institutional Investors Holding, Market-Maker System, and Stock Liquidity: An Empirical Study Based on the NEEQ Market

2018 ◽  
Vol 22 (4) ◽  
pp. 429-436
Author(s):  
Yang Wang ◽  
Keyword(s):  
Empirical Study ◽  
Institutional Investors ◽  
Private Ownership ◽  
Market Maker ◽  
Market Making ◽  
Stock Liquidity

This paper demonstrates the influence of institutional investors shareholding on stock liquidity by means of samples from the NEEQ market from 2014 to 2016. The results of this study suggest that, first, institutional investors shareholding will reduce the liquidity of stocks under agreement trading, and the higher the proportion of shareholding, the worse will become the liquidity. Second, shareholding by institutional investors significantly increases the liquidity of stocks under market-making trade. Third, owing to the function of class market making, the influence of private ownership on liquidity is more positive than that of other kinds of institutional shareholding.

scholarly journals What is the employment potential of a lean platform? The case of Dutch self-employed service professionals

2020 ◽  
Vol ahead-of-print (ahead-of-print) ◽  
Author(s):  
Paul Jonker-Hoffrén
Keyword(s):  
Supply And Demand ◽  
Price Setting ◽  
Data Set ◽  
Content Type ◽  
Setting Mechanism ◽  
System Data ◽  
Service Jobs ◽  
Employment Potential ◽  
The Impact ◽  
Practical Implications

PurposeThe purpose of this article is to study what platform-related user factors influence the employment potential of a lean platform for self-employed professionals.Design/methodology/approachThe article employs the system data of a Dutch platform firm, which include consumers looking for painters (N = 17,224) and self-employed painters (N = 1,752) who pursue client acquisition by submitting proposals (N = 101,974). This data is analysed using non-parametric tests.FindingsStudy of this platform shows that the platform functions as a channel of acquisition for self-employed professionals. This lean platform enables matching of information of supply and demand, thereby facilitating processes of acquisition. The number of competitors, distance to a potential job and non-standard proposals are statistically significant factors that influence whether a consumer is interested in a proposal. Effect sizes are very small.Research limitations/implicationsThis platform is a two-way market for information about service jobs, which excludes a price setting mechanism. The findings of this study cannot be generalized to other forms of platforms.Practical implicationsThe market for service professionals is very local; therefore, the platform firm may alter the algorithm to accommodate this. Self-employed professionals should approach using the platform in the same way as normal forms of acquisition.Social implicationsThis particular type of two-sided market is an extension of regular forms of acquisition by creating “weak ties” through the platform.Originality/valueThe article uses a unique data set to study the impact and limitations of digitalization of the (labour) market for service professionals.

A NOTE ON NOMINAL GDP TARGETING AND THE ZERO LOWER BOUND

2016 ◽  
Vol 21 (8) ◽  
pp. 2138-2157 ◽  
Author(s):  
Roberto M. Billi
Keyword(s):  
Lower Bound ◽  
Central Bank ◽  
Interest Rates ◽  
Price Level ◽  
Supply And Demand ◽  
New Keynesian ◽  
Zero Lower Bound ◽  
Supply And Demand Shocks ◽  
Keynesian Model ◽  
Nominal Interest Rates

I compare nominal gross domestic product (GDP) level targeting with strict price level targeting in a small New Keynesian model, with the central bank operating under optimal discretion and facing a zero lower bound on nominal interest rates. I show that, if the economy is only buffeted by purely temporary shocks to inflation, nominal GDP level targeting may be preferable because it requires the burden of the shocks to be shared by prices and output. However, in the presence of persistent supply and demand shocks, strict price level targeting may be superior because it induces greater policy inertia and improves the tradeoffs faced by the central bank. During lower bound episodes, somewhat paradoxically, nominal GDP level targeting leads to larger falls in nominal GDP.

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