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Inefficiency of CFMs: hedging perspective and agent-based simulations

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  • Samuel Cohen
  • Marc Sabat'e Vidales
  • David v{S}iv{s}ka
  • {L}ukasz Szpruch

Abstract

We investigate whether the fee income from trades on the CFM is sufficient for the liquidity providers to hedge away the exposure to market risk. We first analyse this problem through the lens of continuous-time financial mathematics and derive an upper bound for not-arbitrage fee income that would make CFM efficient and liquidity provision fair. We then evaluate our findings by performing multi-agent simulations by varying CFM fees, market volatility, and rate of arrival of liquidity takers. We observe that, on average, fee income generated from liquidity provision is insufficient to compensate for market risk.

Suggested Citation

  • Samuel Cohen & Marc Sabat'e Vidales & David v{S}iv{s}ka & {L}ukasz Szpruch, 2023. "Inefficiency of CFMs: hedging perspective and agent-based simulations," Papers 2302.04345, arXiv.org.
    • Handle: RePEc:arx:papers:2302.04345
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    4. Grossman, S.J. & Miller, M.H., 1988. "Liquidity And Market Structure," Papers 88, Princeton, Department of Economics - Financial Research Center.
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    6. Albert S. Kyle, 1989. "Informed Speculation with Imperfect Competition," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 56(3), pages 317-355.
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    Cited by:

    1. Werner Brönnimann & Pascal Egloff & Thomas Krabichler, 2024. "Automated market makers and their implications for liquidity providers," Digital Finance, Springer, vol. 6(3), pages 573-604, September.

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