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Market making, price formation, and technical trading

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  • Doyne Farmer, John Geanakoplos, and Paul Melby

Abstract

We demonstrate that achieving sensible convergence of prices to equilibrium is facilitated by market maker risk. \\ We introduce several criteria for price formation rules, and provide an example that satisfies all of them. The risk aversion of the market maker inevitably leads to price persistence that can be exploited by technical traders. \\ We conjecture that this can force a situation in which a market is informationally but not alloactively efficient. Adding more realism by imposing credit limits creates nonlinearities that can cause prices to oscillate even in the absence of external information.

Suggested Citation

  • Doyne Farmer, John Geanakoplos, and Paul Melby, 2001. "Market making, price formation, and technical trading," Computing in Economics and Finance 2001 111, Society for Computational Economics.
    • Handle: RePEc:sce:scecf1:111
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    More about this item

    Keywords

    market making; price formation; technical trading; optimal control; credit limits; institutional constraints; dynamical systems; market efficiency;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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