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Market making with asymmetric information and inventory risk

Listed author(s):
  • Liu, Hong
  • Wang, Yajun
Registered author(s):

    Market makers in some financial markets often make offsetting trades and have significant market power. We develop a market making model that captures these market features as well as other important characteristics such as information asymmetry and inventory risk. In contrast to the existing literature, a market maker in our model can optimally shift some trades with some investors to other investors by adjusting bid or ask. As a result, we find that consistent with empirical evidence, expected bid–ask spreads may decrease with information asymmetry and bid–ask spreads can be positively correlated with trading volume.

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    File URL: http://www.sciencedirect.com/science/article/pii/S0022053116000065
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    Article provided by Elsevier in its journal Journal of Economic Theory.

    Volume (Year): 163 (2016)
    Issue (Month): C ()
    Pages: 73-109

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    Handle: RePEc:eee:jetheo:v:163:y:2016:i:c:p:73-109
    DOI: 10.1016/j.jet.2016.01.005
    Contact details of provider: Web page: http://www.elsevier.com/locate/inca/622869

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