Non cooperative Liquidity Games and their application to bond market trading

TL;DR

This paper introduces Liquidity Games, a novel non-cooperative game model inspired by the UK bond market, where agents' utilities depend on market liquidity, providing new insights into strategic behavior and market design.

Contribution

The paper proposes Liquidity Games, a new game-theoretic framework linking market liquidity to agent utilities, with applications to bond market strategy and regulation.

Findings

Analysis of market maker strategies under uncertainty.

Insights into optimal market design for liquidity.

Demonstration of the model's applicability to bond markets.

Abstract

We present a new type of game, the Liquidity Game. We draw inspiration from the UK government bond market and apply game theoretic approaches to its analysis. In Liquidity Games, market participants (agents) use non-cooperative games where the players' utility is directly defined by the liquidity of the game itself, offering a paradigm shift in our understanding of market dynamics. Each player's utility is intricately linked to the liquidity generated within the game, making the utility endogenous and dynamic. Players are not just passive recipients of utility based on external factors but active participants whose strategies and actions collectively shape and are shaped by the liquidity of the market. This reflexivity introduces a level of complexity and realism previously unattainable in conventional models. We apply Liquidity Game theoretic approaches to a simple UK bond market interaction and present results for market design and strategic behavior of participants. We tackle one of the largest issues within this mechanism, namely what strategy should market makers utilize when uncertain about the type of market maker they are interacting with, and what structure might regulators wish to see.