Optimal liquidity provision (Q2348293)

The paper concerns a limit order market model, where the mid price follows \[ \frac{dS_t}{S_t}=\sigma_tdW_t,\quad S_0>0, \] for a Brownian motion \(W_t\) and a volatility process \(\sigma_t\). The main results are a trading policy for a small investor that is optimal for small spreads and frequent orders of other market participants, and an explicit formula for the utility that can be obtained by applying it. The basic model is also extended to incorporate the price impact of incoming orders. In this extension the mid price follows \[ \frac{dS_t}{S_{t-}}=\sigma_tdW_t-\kappa\varepsilon_tdN^{(1)}+\kappa\varepsilon_tdN_t^{(2)}, \] with \(\kappa\in[0, 1)\), where \(N_t^{(1)}\) and \(N_t^{(2)}\) count the sell and buy orders respectively.