In most over‐the‐counter (OTC) markets, a small number of market makers provide liquidity to other market participants. More precisely, for a list of assets, they set prices at which they agree to buy and sell. Market makers face therefore an interesting optimization problem: they need to choose bid and ask prices for making money while mitigating the risk associated with holding inventory in a volatile market. Many market‐making models have been proposed in the academic literature, most of them dealing with single‐asset market making whereas market makers are usually in charge of a long list of assets. The rare models tackling multiasset market making suffer however from the curse of dimensionality when it comes to the numerical approximation of the optimal quotes. The goal of this paper is to propose a dimensionality reduction technique to address multiasset market making by using a factor model. Moreover, we generalize existing market‐making models by the addition of an important feature: the existence of different transaction sizes and the possibility for the market makers in OTC markets to answer different prices to requests with different sizes.
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 (FX) markets or corporate bond markets. Over the last 10 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 interdealer 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.
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