Welfare Effects of Market Making in Continuous Double Auctions

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.

A DYNAMIC ANALYSIS OF THE MICROSTRUCTURE OF MOVING AVERAGE RULES IN A DOUBLE AUCTION MARKET

Inspired by the theoretically oriented dynamic analysis of moving average rules in the model of Chiarella, He, and Hommes (CHH) [Journal of Economic Dynamics and Control30 (2006), 1729—1753], this paper conducts a dynamic analysis of a more realistic microstructure model of continuous double auctions in which the probability of heterogeneous agents trading is determined by the rules of either fundamentalists mean-reverting to the fundamental or chartists choosing moving average rules based on their relative performance. With such a realistic market microstructure, the model is able not only to obtain the results of the CHH model but also to characterize most of the stylized facts including volatility clustering, insignificant autocorrelations (ACs) of returns, and significant slowly decaying ACs of the absolute returns. The results seem to suggest that a comprehensive explanation of several statistical properties of returns is possible in a framework where bothbehavioraltraits andrealistic microstructurehave a role.

Automated Fuzzy Bidding Strategy for Continuous Double Auctions Using Trading Agent’s Attitude and Market Competition

This paper designs a novel fuzzy competition and attitude based bidding strategy (FCA-Bid) for continuous double auction in which the best transaction price is calculated on account of the attitude of the agents and the competition for the goods in the market. The estimation of attitude is based on the bidding item’s attribute assessment, which adapts the fuzzy sets technique to handle uncertainty of the bidding process. Additionally, it uses heuristic rules to determine the attitude of bidding agents. The bidding strategy also uses and determines competition in the market (based on the two factors, number of the bidders participating and the total time elapsed for an auction) using Mamdani’s Direct Method. Then the range for the trading price will be determined based on the assessed attitude and the competition in the market using the fuzzy reasoning technique. The final transaction price is calculated after considering the conflicting attitudes of the seller and the bidder toward selecting the transaction price.