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Modeling liquidity in corporate bond markets: applications to price adjustments

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  • Philippe Bergault
  • Olivier Gu'eant

Abstract

To assign a value to a portfolio, it is common to use Mark-to-Market prices. But how to proceed when the securities are illiquid? When transaction prices are scarce, how to use other available real-time information? In this article dedicated to corporate bonds, we address these questions using an extension of the concept of micro-price recently introduced for assets exchanged on limit order books in the market microstructure literature and ideas coming from the recent literature on OTC market making. To account for liquidity imbalances in OTC markets, we use a novel approach based on Markov-modulated Poisson processes. Beyond an extension to corporate bonds of the concept of micro-price, we coin the new concept of Fair Transfer Price that can be used to value or transfer securities in a fair manner even when the market is illiquid and/or tends to be one-sided.

Suggested Citation

  • Philippe Bergault & Olivier Gu'eant, 2023. "Modeling liquidity in corporate bond markets: applications to price adjustments," Papers 2309.04216, arXiv.org, revised Oct 2023.
    • Handle: RePEc:arx:papers:2309.04216
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    References listed on IDEAS

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    1. 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.
    2. Philippe Bergault & Olivier Guéant, 2021. "Size matters for OTC market makers: General results and dimensionality reduction techniques," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) hal-03252557, HAL.
    3. Marco Avellaneda & Sasha Stoikov, 2008. "High-frequency trading in a limit order book," Quantitative Finance, Taylor & Francis Journals, vol. 8(3), pages 217-224.
    4. Glosten, Lawrence R. & Milgrom, Paul R., 1985. "Bid, ask and transaction prices in a specialist market with heterogeneously informed traders," Journal of Financial Economics, Elsevier, vol. 14(1), pages 71-100, March.
    5. Rama Cont & Adrien de Larrard, 2013. "Price Dynamics in a Markovian Limit Order Market," Post-Print hal-00552252, HAL.
    6. Meier-Hellstern, K. S., 1987. "A fitting algorithm for Markov-modulated poisson processes having two arrival rates," European Journal of Operational Research, Elsevier, vol. 29(3), pages 370-377, June.
    7. Alexander Barzykin & Philippe Bergault & Olivier Guéant, 2023. "Algorithmic market making in dealer markets with hedging and market impact," Mathematical Finance, Wiley Blackwell, vol. 33(1), pages 41-79, January.
    8. Olivier Guéant & Iuliia Manziuk, 2020. "Optimal control on graphs: existence, uniqueness, and long-term behavior," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) hal-03252606, HAL.
    9. Madhavan, Ananth & Richardson, Matthew & Roomans, Mark, 1997. "Why Do Security Prices Change? A Transaction-Level Analysis of NYSE Stocks," The Review of Financial Studies, Society for Financial Studies, vol. 10(4), pages 1035-1064.
    10. Philippe Bergault & Olivier Guéant & David Evangelista & Douglas Vieira, 2021. "Closed-form Approximations in Multi-asset Market Making," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) hal-03680074, HAL.
    11. Philippe Bergault & Olivier Guéant & David Evangelista & Douglas Vieira, 2021. "Closed-form Approximations in Multi-asset Market Making," Post-Print hal-03680074, HAL.
    12. Sasha Stoikov, 2018. "The micro-price: a high-frequency estimator of future prices," Quantitative Finance, Taylor & Francis Journals, vol. 18(12), pages 1959-1966, December.
    13. Philippe Bergault & Olivier Guéant, 2021. "Size matters for OTC market makers: General results and dimensionality reduction techniques," Post-Print hal-03252557, HAL.
    14. Philippe Bergault & David Evangelista & Olivier Guéant & Douglas Vieira, 2021. "Closed-form Approximations in Multi-asset Market Making," Applied Mathematical Finance, Taylor & Francis Journals, vol. 28(2), pages 101-142, March.
    15. Christian Y. Robert & Mathieu Rosenbaum, 2011. "A New Approach for the Dynamics of Ultra-High-Frequency Data: The Model with Uncertainty Zones," Journal of Financial Econometrics, Oxford University Press, vol. 9(2), pages 344-366, Spring.
    16. Olivier Guéant & Iuliia Manziuk, 2020. "Optimal control on graphs: existence, uniqueness, and long-term behavior," Post-Print hal-03252606, HAL.
    17. Philippe Bergault & Olivier Guéant, 2021. "Size matters for OTC market makers: General results and dimensionality reduction techniques," Post-Print hal-03885108, HAL.
    18. Philippe Bergault & Olivier Guéant, 2021. "Size matters for OTC market makers: General results and dimensionality reduction techniques," Mathematical Finance, Wiley Blackwell, vol. 31(1), pages 279-322, January.
    19. Álvaro Cartea & Ryan Donnelly & Sebastian Jaimungal, 2018. "Enhancing trading strategies with order book signals," Applied Mathematical Finance, Taylor & Francis Journals, vol. 25(1), pages 1-35, January.
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    21. Philippe Bergault & David Evangelista & Olivier Guéant & Douglas Vieira, 2021. "Closed-form Approximations in Multi-asset Market Making," Post-Print hal-03885121, HAL.
    22. Olivier Gu'eant, 2016. "Optimal market making," Papers 1605.01862, arXiv.org, revised May 2017.
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