Algorithmic market making in dealer markets with hedging and market impact

DOI10.1111/MAFI.12367zbMATH Open1522.91237arXiv2106.06974OpenAlexW4309357964MaRDI QIDQ6054445FDOQ6054445

Authors: Philippe Bergault, Olivier Guéant 

Publication date: 28 September 2023

Published in: Mathematical Finance (Search for Journal in Brave)

Abstract: In dealer markets, dealers provide prices at which they agree to buy and sell the assets and securities they have in their scope. With ever increasing trading volume, this quoting task has to be done algorithmically in most markets such as foreign exchange markets or corporate bond markets. Over the last ten years, many mathematical models have been designed that can be the basis of quoting algorithms in dealer markets. Nevertheless, in most (if not all) models, the dealer is a pure internalizer, setting quotes and waiting for clients. However, on many dealer markets, dealers also have access to an inter-dealer market or even public trading venues where they can hedge part of their inventory. In this paper, we propose a model taking this possibility into account, therefore allowing dealers to externalize part of their risk. The model displays an important feature well known to practitioners that within a certain inventory range the dealer internalizes the flow by appropriately adjusting the quotes and starts externalizing outside of that range. The larger the franchise, the wider is the inventory range suitable for pure internalization. The model is illustrated numerically with realistic parameters for USDCNH spot market.

Full work available at URL: https://arxiv.org/abs/2106.06974

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zbMATH Keywords

stochastic optimal controlviscosity solutionsmarket makingalgorithmic tradingdealer markets

Mathematics Subject Classification ID

Financial markets (91G15) Optimal stochastic control (93E20)

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Cited In (6)

• Internalisation by electronic FX spot dealers
• Dynamics of market making algorithms in dealer markets: Learning and tacit collusion
• Towards multi‐agent reinforcement learning‐driven over‐the‐counter market simulations
• A Mean-Field Game of Market-Making against Strategic Traders
• A theory of Automated Market Makers in DeFi
• Numerical analysis of an extended mean field game for harvesting common fishery resource

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