How to design a derivatives market?

TL;DR

This paper proposes a systematic approach to designing a derivatives exchange by selecting options through quantization and incentivizing market makers with a tailored fee contract to ensure liquidity and meet client needs.

Contribution

It introduces a novel two-step framework combining quantization and principal-agent modeling for derivatives market design.

Findings

Effective option selection via quantization.

Incentive-compatible make-take fee structure.

Enhanced liquidity and client satisfaction.

Abstract

We consider the problem of designing a derivatives exchange aiming at addressing clients needs in terms of listed options and providing suitable liquidity. We proceed into two steps. First we use a quantization method to select the options that should be displayed by the exchange. Then, using a principal-agent approach, we design a make take fees contract between the exchange and the market maker. The role of this contract is to provide incentives to the market maker so that he offers small spreads for the whole range of listed options, hence attracting transactions and meeting the commercial requirements of the exchange.