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The optimal pricing of a market maker in a heterogeneous agent economy

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  • Guo, Bin
  • Zhang, Wei
  • Chen, Shu-Heng
  • Zhang, Yongjie

Abstract

This paper extends some classical models, built upon the representative-agent and Walrasian market-clearing mechanism, into one characterized by a market-maker trading mechanism with investors having heterogeneous beliefs regarding the likely future payoff of a risky security. We show the optimal determination of the bid and ask prices and resultant trading volume. The endogenously-determined spread and volume are increasing with the degree of the heterogeneity of investors’ beliefs. We analyze the market marker’s risk exposure based on his inventory, under the condition in which he is fully informed of the investors’ beliefs, and under the condition in which he is not.

Suggested Citation

  • Guo, Bin & Zhang, Wei & Chen, Shu-Heng & Zhang, Yongjie, 2015. "The optimal pricing of a market maker in a heterogeneous agent economy," Finance Research Letters, Elsevier, vol. 14(C), pages 178-187.
    • Handle: RePEc:eee:finlet:v:14:y:2015:i:c:p:178-187
    DOI: 10.1016/j.frl.2015.04.001
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    More about this item

    Keywords

    Market-maker trading mechanism; Bid-ask prices; Heterogeneous agent economy;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations

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