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Intraday market making with overnight inventory costs

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  • Adrian, Tobias
  • Capponi, Agostino
  • Fleming, Michael
  • Vogt, Erik
  • Zhang, Hongzhong

Abstract

The U.S. Treasury market is highly intermediated by non-bank principal trading firms (PTFs). Limited capital forces PTFs to end the trading day close to flat. We construct a continuous time market making model to analyze the trade-off faced by a profit maximizing firm with overnight inventory costs, and develop closed-form representations of the optimal price policy functions. Our model reveals that bid-ask spreads widen as the end of the trading day approaches, and that increases in order arrival rates do not always lead to higher price volatility. Our empirical analysis shows that Treasury security trading costs increase as the close of trading approaches, consistent with model predictions.

Suggested Citation

  • Adrian, Tobias & Capponi, Agostino & Fleming, Michael & Vogt, Erik & Zhang, Hongzhong, 2020. "Intraday market making with overnight inventory costs," Journal of Financial Markets, Elsevier, vol. 50(C).
    • Handle: RePEc:eee:finmar:v:50:y:2020:i:c:s1386418120300331
    DOI: 10.1016/j.finmar.2020.100564
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    Cited by:

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    2. Bastien Baldacci & Philippe Bergault & Joffrey Derchu & Mathieu Rosenbaum, 2020. "On bid and ask side-specific tick sizes," Papers 2005.14126, arXiv.org, revised May 2020.
    3. Matthew Lorig & Zhou Zhou & Bin Zou, 2019. "Optimal Bookmaking," Papers 1907.01056, arXiv.org, revised Mar 2021.
    4. Min Dai & Steven Kou & H. Mete Soner & Chen Yang, 2023. "Leveraged Exchange-Traded Funds with Market Closure and Frictions," Management Science, INFORMS, vol. 69(4), pages 2517-2535, April.
    5. Yu An & Zeyu Zheng, 2023. "Immediacy Provision and Matchmaking," Management Science, INFORMS, vol. 69(2), pages 1245-1263, February.
    6. Agostino Capponi & Jos'e E. Figueroa-L'opez & Chuyi Yu, 2021. "Market Making with Stochastic Liquidity Demand: Simultaneous Order Arrival and Price Change Forecasts," Papers 2101.03086, arXiv.org.
    7. Ivan Guo & Shijia Jin & Kihun Nam, 2023. "Macroscopic Market Making," Papers 2307.14129, arXiv.org, revised Jun 2024.
    8. Jonathan Ch'avez-Casillas & Jos'e E. Figueroa-L'opez & Chuyi Yu & Yi Zhang, 2024. "Adaptive Optimal Market Making Strategies with Inventory Liquidation Cos," Papers 2405.11444, arXiv.org.
    9. Farshid Abdi & Botao Wu, 2018. "Informed Corporate Credit Market Before Monetary Policy Surprises: Explaining Pre-FOMC Stock Market Movements," Working Papers on Finance 1828, University of St. Gallen, School of Finance.
    10. Lorig, Matthew & Zhou, Zhou & Zou, Bin, 2021. "Optimal bookmaking," European Journal of Operational Research, Elsevier, vol. 295(2), pages 560-574.

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    More about this item

    Keywords

    Market microstructure theory; Market liquidity; Market making; Financial intermediation;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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