Optimal market-making with risk aversion

Kan Huang, David Simchi-Levi, Miao Song

Research output: Journal article publicationJournal articleAcademic researchpeer-review

5 Citations (Scopus)

Abstract

Market-makers have the obligation to trade any given amount of assets at quoted bid or ask prices, and their inventories are exposed to the potential loss when the market price moves in an undesirable direction. One approach to reduce the risk brought by price uncertainty is to adjust the inventory at the price of losing potential spread gain. Using stochastic dynamic programming, we show that a threshold inventory control policy is optimal with respect to an exponential utility criterion and a mean-variance trade-off model. Symmetric and monotone properties of the threshold levels are also established.
Original languageEnglish
Pages (from-to)541-565
Number of pages25
JournalOperations Research
Volume60
Issue number3
DOIs
Publication statusPublished - 1 May 2012
Externally publishedYes

ASJC Scopus subject areas

  • Computer Science Applications
  • Management Science and Operations Research

Cite this