The optimal pricing of a market maker in a heterogeneous agent economy

Bin Guo, Wei Zhang, Shu-Heng Chen and Yongjie Zhang

Finance Research Letters, 2015, vol. 14, issue C, 178-187

Abstract: This paper extends some classical models, built upon the representative-agent and Walrasian market-clearing mechanism, into one characterized by a market-maker trading mechanism with investors having heterogeneous beliefs regarding the likely future payoff of a risky security. We show the optimal determination of the bid and ask prices and resultant trading volume. The endogenously-determined spread and volume are increasing with the degree of the heterogeneity of investors’ beliefs. We analyze the market marker’s risk exposure based on his inventory, under the condition in which he is fully informed of the investors’ beliefs, and under the condition in which he is not.

Keywords: Market-maker trading mechanism; Bid-ask prices; Heterogeneous agent economy (search for similar items in EconPapers)
JEL-codes: D82 D84 G10 G12 (search for similar items in EconPapers)
Date: 2015
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:finlet:v:14:y:2015:i:c:p:178-187

DOI: 10.1016/j.frl.2015.04.001

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