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Market Making in Spot Precious Metals

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  • Alexander Barzykin
  • Philippe Bergault
  • Olivier Gu'eant

Abstract

The primary challenge of market making in spot precious metals is navigating the liquidity that is mainly provided by futures contracts. The Exchange for Physical (EFP) spread, which is the price difference between futures and spot, plays a pivotal role and exhibits multiple modes of relaxation corresponding to the diverse trading horizons of market participants. In this paper, we model the EFP spread using a nested Ornstein-Uhlenbeck process, in the spirit of the two-factor Hull-White model for interest rates. We demonstrate the suitability of the framework for maximizing the expected P\&L of a market maker while minimizing inventory risk across both spot and futures. Using a computationally efficient technique to approximate the solution of the Hamilton-Jacobi-Bellman equation associated with the corresponding stochastic optimal control problem, our methodology facilitates strategy optimization on demand in near real-time, paving the way for advanced algorithmic market making that capitalizes on the co-integration properties intrinsic to the precious metals sector.

Suggested Citation

  • Alexander Barzykin & Philippe Bergault & Olivier Gu'eant, 2024. "Market Making in Spot Precious Metals," Papers 2404.15478, arXiv.org, revised Dec 2024.
    • Handle: RePEc:arx:papers:2404.15478
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    References listed on IDEAS

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    1. Alexander Lipton & Marcos López De Prado, 2020. "A Closed-Form Solution For Optimal Ornstein–Uhlenbeck Driven Trading Strategies," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 23(08), pages 1-34, December.
    2. M. Butz & R. Oomen, 2019. "Internalisation by electronic FX spot dealers," Quantitative Finance, Taylor & Francis Journals, vol. 19(1), pages 35-56, January.
    3. Fabien Guilbaud & Huyên Pham, 2013. "Optimal high-frequency trading with limit and market orders," Quantitative Finance, Taylor & Francis Journals, vol. 13(1), pages 79-94, January.
    4. Marco Avellaneda & Sasha Stoikov, 2008. "High-frequency trading in a limit order book," Quantitative Finance, Taylor & Francis Journals, vol. 8(3), pages 217-224.
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    Cited by:

    1. Marcello Monga, 2024. "Automated Market Making and Decentralized Finance," Papers 2407.16885, arXiv.org.

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