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Intraday market making with overnight inventory costs

Tobias Adrian (), Agostino Capponi, Michael Fleming (), Erik Vogt and Hongzhong Zhang

Journal of Financial Markets, 2020, vol. 50, issue C

Abstract: The U.S. Treasury market is highly intermediated by non-bank principal trading firms (PTFs). Limited capital forces PTFs to end the trading day close to flat. We construct a continuous time market making model to analyze the trade-off faced by a profit maximizing firm with overnight inventory costs, and develop closed-form representations of the optimal price policy functions. Our model reveals that bid-ask spreads widen as the end of the trading day approaches, and that increases in order arrival rates do not always lead to higher price volatility. Our empirical analysis shows that Treasury security trading costs increase as the close of trading approaches, consistent with model predictions.

Keywords: Market microstructure theory; Market liquidity; Market making; Financial intermediation (search for similar items in EconPapers)
JEL-codes: G12 G17 G23 (search for similar items in EconPapers)
Date: 2020
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Working Paper: Intraday Market Making with Overnight Inventory Costs (2017) Downloads
Working Paper: Intraday market making with overnight inventory costs (2016) Downloads
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DOI: 10.1016/j.finmar.2020.100564

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