A Model of Market Making and Price Impact
Angad Singh

TL;DR
This paper models market making as a dynamic auction using stochastic differential games, revealing how quoting strategies produce a price impact similar to the Almgren-Chriss model, crucial for market liquidity and profitability.
Contribution
It introduces a novel stochastic differential game framework to derive the emergence of price impact from market maker strategies, linking it to profit mechanisms.
Findings
Price impact function matches Almgren-Chriss form
Market makers' strategies generate profit through price impact
Price impact is essential for market liquidity
Abstract
Traders constantly consider the price impact associated with changing their positions. This paper seeks to understand how price impact emerges from the quoting strategies of market makers. To this end, market making is modeled as a dynamic auction using the mathematical framework of Stochastic Differential Games. In Nash Equilibrium, the market makers' quoting strategies generate a price impact function that is of the same form as the celebrated Almgren-Chriss model. The key insight is that price impact is the mechanism through which market makers earn profits while matching their books. As such, price impact is an essential feature of markets where flow is intermediated by market makers.
Peer Reviews
No public reviews on file for this paper yet. If you reviewed it on a platform where reviews are public (OpenReview, ICLR, NeurIPS, ICML), you can paste yours below so the community can read it here.
Videos
No videos yet. Explain this paper in a talk, walkthrough, or lecture? Add one.
Taxonomy
TopicsComplex Systems and Time Series Analysis · Economic theories and models · Stochastic processes and financial applications
