FX Market Making with Internal Liquidity

TL;DR

This paper explores optimal strategies for FX market makers managing internal liquidity pools, considering market conditions, risk appetite, and client algorithms to improve execution and risk management.

Contribution

It introduces a multi-objective framework for FX market makers to optimize internal liquidity management, providing new insights into strategy design under various market scenarios.

Findings

Optimal strategies depend on market volatility and risk preferences.

Internal liquidity actions significantly impact execution speed and risk.

The framework guides market makers in balancing profit, risk, and execution quality.

Abstract

As the FX markets continue to evolve, many institutions have started offering passive access to their internal liquidity pools. Market makers act as principal and have the opportunity to fill those orders as part of their risk management, or they may choose to adjust pricing to their external OTC franchise to facilitate the matching flow. It is, a priori, unclear how the strategies managing internal liquidity should depend on market condions, the market maker's risk appetite, and the placement algorithms deployed by participating clients. The market maker's actions in the presence of passive orders are relevant not only for their own objectives, but also for those liquidity providers who have certain expectations of the execution speed. In this work, we investigate the optimal multi-objective strategy of a market maker with an option to take liquidity on an internal exchange, and draw important qualitative insights for real-world trading.