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Algorithmic market making in dealer markets with hedging and market impact

Author

Listed:
  • Alexander Barzykin
  • Philippe Bergault

    (CMAP - Centre de Mathématiques Appliquées de l'Ecole polytechnique - Inria - Institut National de Recherche en Informatique et en Automatique - X - École polytechnique - IP Paris - Institut Polytechnique de Paris - CNRS - Centre National de la Recherche Scientifique)

  • Olivier Guéant

Abstract

In dealer markets, dealers provide prices at which they agree to buy and sell the assets and securities they have in their scope. With ever increasing trading volume, this quoting task has to be done algorithmically in most markets such as foreign exchange markets or corporate bond markets. Over the last ten years, many mathematical models have been designed that can be the basis of quoting algorithms in dealer markets. Nevertheless, in most (if not all) models, the dealer is a pure internalizer, setting quotes and waiting for clients. However, on many dealer markets, dealers also have access to an inter-dealer market or even public trading venues where they can hedge part of their inventory. In this paper, we propose a model taking this possibility into account, therefore allowing dealers to externalize part of their risk. The model displays an important feature well known to practitioners that within a certain inventory range the dealer internalizes the flow by appropriately adjusting the quotes and starts externalizing outside of that range. The larger the franchise, the wider is the inventory range suitable for pure internalization. The model is illustrated numerically with realistic parameters for USDCNH spot market.

Suggested Citation

  • Alexander Barzykin & Philippe Bergault & Olivier Guéant, 2022. "Algorithmic market making in dealer markets with hedging and market impact," Post-Print hal-03885137, HAL.
    • Handle: RePEc:hal:journl:hal-03885137
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    Cited by:

    1. Alexander Barzykin & Philippe Bergault & Olivier Gu'eant & Malo Lemmel, 2025. "Optimal Quoting under Adverse Selection and Price Reading," Papers 2508.20225, arXiv.org, revised Nov 2025.
    2. Vincent Ragel & Damien Challet, 2024. "Consistent time travel for realistic interactions with historical data: reinforcement learning for market making," Papers 2408.02322, arXiv.org, revised Jan 2025.
    3. Philippe Bergault & Louis Bertucci & David Bouba & Olivier Gu'eant & Julien Guilbert, 2024. "Price-Aware Automated Market Makers: Models Beyond Brownian Prices and Static Liquidity," Papers 2405.03496, arXiv.org, revised May 2024.
    4. Kubo, Kenji & Nakagawa, Kei & Mizukami, Daiki & Acharya, Dipesh, 2023. "Optimal liquidation strategy for cryptocurrency marketplaces using stochastic control," Finance Research Letters, Elsevier, vol. 53(C).
    5. Philippe Bergault & Pierre Cardaliaguet & Wenbin Yan, 2025. "Optimal hedging of an informed broker facing many traders," Papers 2506.08992, arXiv.org.
    6. Philippe Bergault & Louis Bertucci & David Bouba & Olivier Gu'eant & Julien Guilbert, 2024. "Automated Market Making: the case of Pegged Assets," Papers 2411.08145, arXiv.org.
    7. Sergio Pulido & Mathieu Rosenbaum & Emmanouil Sfendourakis, 2025. "Understanding the worst-kept secret of high-frequency trading," Post-Print hal-04362236, HAL.
    8. Philippe Bergault & Olivier Gu'eant & Hamza Bodor, 2025. "To Hedge or Not to Hedge: Optimal Strategies for Stochastic Trade Flow Management," Papers 2503.02496, arXiv.org.
    9. Sergio Pulido & Mathieu Rosenbaum & Emmanouil Sfendourakis, 2023. "Understanding the worst-kept secret of high-frequency trading," Papers 2307.15599, arXiv.org, revised Jul 2024.
    10. Philippe Bergault & Olivier Gu'eant, 2023. "Liquidity Dynamics in RFQ Markets and Impact on Pricing," Papers 2309.04216, arXiv.org, revised Jun 2024.
    11. Alexander Barzykin & Robert Boyce & Eyal Neuman, 2024. "Unwinding Toxic Flow with Partial Information," Papers 2407.04510, arXiv.org.
    12. Marcello Monga, 2024. "Automated Market Making and Decentralized Finance," Papers 2407.16885, arXiv.org.
    13. Philippe Bergault & Leandro S'anchez-Betancourt, 2024. "A Mean Field Game between Informed Traders and a Broker," Papers 2401.05257, arXiv.org.
    14. Emilio Barucci & Adrien Mathieu & Leandro S'anchez-Betancourt, 2025. "Market Making with Fads, Informed, and Uninformed Traders," Papers 2501.03658, arXiv.org, revised Feb 2025.
    15. Marcel Nutz & Kevin Webster & Long Zhao, 2023. "Unwinding Stochastic Order Flow: When to Warehouse Trades," Papers 2310.14144, arXiv.org, revised Nov 2025.
    16. 'Alvaro Cartea & Leandro S'anchez-Betancourt, 2025. "A Simple Strategy to Deal with Toxic Flow," Papers 2503.18005, arXiv.org.

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