Dealing with multi-currency inventory risk in FX cash markets

Alexander Barzykin, Philippe Bergault and Olivier Guéant
Additional contact information
Alexander Barzykin: HSBC
Philippe Bergault: CMAP - Centre de Mathématiques Appliquées de l'Ecole polytechnique - Inria - Institut National de Recherche en Informatique et en Automatique - X - École polytechnique - IP Paris - Institut Polytechnique de Paris - CNRS - Centre National de la Recherche Scientifique

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Abstract: In FX cash markets, market makers provide liquidity to clients for a wide variety of currency pairs. Because of flow uncertainty and market volatility, they face inventory risk. To mitigate this risk, they typically skew their prices to attract or divert the flow and trade with their peers on the dealer-to-dealer segment of the market for hedging purposes. This paper offers a mathematical framework to FX dealers willing to maximize their expected profit while controlling their inventory risk. Approximation techniques are proposed which make the framework scalable to any number of currency pairs.

Keywords: Market making; foreign exchange market; internalization; stochastic optimal control; Riccati equations; closed-form approximations (search for similar items in EconPapers)
Date: 2022-11-17
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Working Paper: Dealing with multi-currency inventory risk in FX cash markets (2022)
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