Algorithmic Market Making in Spot Precious Metals

Alexander Barzykin, Philippe Bergault and Olivier Guéant
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Alexander Barzykin: HSBC
Philippe Bergault: Université Paris Dauphine-PSL - PSL - Université Paris Sciences et Lettres

Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) from HAL

Abstract: The primary challenge of market making in spot precious metals is navigating the liquidity that is mainly provided by futures contracts. The Exchange for Physical (EFP) spread, which is the price difference between futures and spot, plays a pivotal role and exhibits multiple modes of relaxation corresponding to the diverse trading horizons of market participants. In this paper, we introduce a novel framework utilizing a nested Ornstein-Uhlenbeck process to model the EFP spread. We demonstrate the suitability of the framework for maximizing the expected P\&L of a market maker while minimizing inventory risk across both spot and futures. Using a computationally efficient technique to approximate the solution of the Hamilton-Jacobi-Bellman equation associated with the corresponding stochastic optimal control problem, our methodology facilitates strategy optimization on demand in near real-time, paving the way for advanced algorithmic market making that capitalizes on the co-integration properties intrinsic to the precious metals sector.

Keywords: Market making; precious metals; internalization-externalization dilemma; edging; stochastic optimal control; Riccati equations; closed-form approximations (search for similar items in EconPapers)
Date: 2024-05-15
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Working Paper: Algorithmic Market Making in Spot Precious Metals (2024)
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Persistent link: https://EconPapers.repec.org/RePEc:hal:cesptp:hal-04577061

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