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Dynamic Market Making with Asymmetric Information and Market Power

Author

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  • Wen Chen
  • Yajun Wang

Abstract

We study the dynamics of trading volume and bid-ask spread using a multiperiod trading model with oligopolistic market makers. Traders smooth out their trading even though they are not strategic, and thus trading persists after the arrival of information or liquidity shocks. Traders act quickly on their private information while postponing hedging trades until later periods. The market power of market makers enables them to widen bid-ask spreads when trading incentives are heightened. Consequently, both trading volume and bid-ask spread may exhibit U-shaped patterns. Our model calibration aligns with the empirical intraday patterns observed in bid-ask spreads and trading volumes. (JEL D53, D61, D82, G12, G14, G18)

Suggested Citation

  • Wen Chen & Yajun Wang, 2025. "Dynamic Market Making with Asymmetric Information and Market Power," The Review of Financial Studies, Society for Financial Studies, vol. 38(1), pages 235-293.
    • Handle: RePEc:oup:rfinst:v:38:y:2025:i:1:p:235-293.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhae062
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    More about this item

    JEL classification:

    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation

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