Does the market maker stabilize the market?

Mei Zhu, Carl Chiarella, Xuezhong (Tony) He () and Duo Wang

Physica A: Statistical Mechanics and its Applications, 2009, vol. 388, issue 15, 3164-3180

Abstract: The market maker plays an important role in price formation, but his/her behavior and stabilizing impact on the market are relatively unclear, in particular in speculative markets. This paper develops a financial market model that examines the impact on market stability of the market maker, who acts as both a liquidity provider and an active investor in a market consisting of two types of boundedly rational speculative investors—the fundamentalists and trend followers. We show that the market maker does not necessarily stabilize the market when he/she actively manages the inventory to maximize profits, and that rather the market maker’s impact depends on the behavior of the speculators. Numerical simulations show that the model is able to generate outcomes for asset returns and market inventories that are consistent with empirical findings.

Keywords: Market maker; Inventory; Speculators; Market stability (search for similar items in EconPapers)
Date: 2009
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (31)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:phsmap:v:388:y:2009:i:15:p:3164-3180

DOI: 10.1016/j.physa.2009.04.013

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