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Spread, volatility, and volume relationship in financial markets and market making profit optimization

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  • Jack Sarkissian

Abstract

We study the relationship between price spread, volatility and trading volume. We find that spread forms as a result of interplay between order liquidity and order impact. When trading volume is small adding more liquidity helps improve price accuracy and reduce spread, but after some point additional liquidity begins to deteriorate price. The model allows to connect the bid-ask spread and high-low bars to measurable microstructural parameters and express their dependence on trading volume, volatility and time horizon. Using the established relations, we address the operating spread optimization problem to maximize market-making profit.

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  • Jack Sarkissian, 2016. "Spread, volatility, and volume relationship in financial markets and market making profit optimization," Papers 1606.07381, arXiv.org.
    • Handle: RePEc:arx:papers:1606.07381
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    References listed on IDEAS

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    1. A. Abhyankar & D. Ghosh & E. Levin & R.J. Limmack, 1997. "Bid‐ask Spreads, Trading Volume and Volatility: Intra‐day Evidence from the London Stock Exchange," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 24(3), pages 343-362, April.
    2. Olivier Gu'eant & Charles-Albert Lehalle & Joaquin Fernandez Tapia, 2011. "Dealing with the Inventory Risk. A solution to the market making problem," Papers 1105.3115, arXiv.org, revised Aug 2012.
    3. Schaden, Martin, 2002. "Quantum finance," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 316(1), pages 511-538.
    4. Marco Avellaneda & Sasha Stoikov, 2008. "High-frequency trading in a limit order book," Quantitative Finance, Taylor & Francis Journals, vol. 8(3), pages 217-224.
    5. Martin Schaden, 2002. "Quantum Finance," Papers physics/0203006, arXiv.org, revised Aug 2002.
    6. Martin Schaden, 2002. "A Quantum Approach to Stock Price Fluctuations," Papers physics/0205053, arXiv.org, revised May 2003.
    7. Zhang, Chao & Huang, Lu, 2010. "A quantum model for the stock market," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 389(24), pages 5769-5775.
    8. Jack Sarkissian, 2013. "Coupled mode theory of stock price formation," Papers 1312.4622, arXiv.org.
    9. Chao Zhang & Lu Huang, 2010. "A quantum model for the stock market," Papers 1009.4843, arXiv.org, revised Oct 2010.
    10. Bollen, Nicolas P. B. & Smith, Tom & Whaley, Robert E., 2004. "Modeling the bid/ask spread: measuring the inventory-holding premium," Journal of Financial Economics, Elsevier, vol. 72(1), pages 97-141, April.
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    Cited by:

    1. Sarkissian, Jack, 2020. "Quantum coupled-wave theory of price formation in financial markets: Price measurement, dynamics and ergodicity," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 554(C).
    2. Hans Ole Riddervold & Ellen Krohn Aasg{aa}rd & Lisa Haukaas & Magnus Korp{aa}s, 2021. "Internal hydro- and wind portfolio optimisation in real-time market operations," Papers 2102.10098, arXiv.org.
    3. Jack Sarkissian, 2020. "Quantum coupled-wave theory of price formation in financial markets: price measurement, dynamics and ergodicity," Papers 2002.04212, arXiv.org.

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