Market making by an FX dealer: tiers, pricing ladders and hedging rates for optimal risk control

Alexander Barzykin, Philippe Bergault and Olivier Gu\'eant

Papers from arXiv.org

Abstract: Dealers make money by providing liquidity to clients but face flow uncertainty and thus price risk. They can efficiently skew their prices and wait for clients to mitigate risk (internalization), or trade with other dealers in the open market to hedge their position and reduce their inventory (externalization). Of course, the better control associated with externalization comes with transaction costs and market impact. The internalization vs. externalization dilemma has been a topic of recent active discussion within the foreign exchange (FX) community. This paper offers an optimal control framework for market making tackling both pricing and hedging, thus answering a question well known to dealers: `to hedge, or not to hedge?'

Date: 2021-12, Revised 2023-06
New Economics Papers: this item is included in nep-fmk and nep-mst
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Persistent link: https://EconPapers.repec.org/RePEc:arx:papers:2112.02269

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