The effects of market-making on price dynamics

This paper studies price properties in continuous double-auction markets in the presence of marketmakers, agents with special responsibilities for maintaining liquidity and orderly price transitions. The effects of market-making are especially important immediately following exogenous price shocks. This paper analyzes the dynamics of prices around such events using simulation techniques and standard measures of market quality like the bid-ask spread. When the market-maker is a monopolistic pricesetter, experiments show that myopic profit-maximization, apart from leading to poor market quality, is sub-optimal even for the market-maker in the sequential context. This observation leads to an interesting characterization of the monopolistic market-maker's exploration-exploitation dilemma as a tradeoff between price discovery and profit-taking. When traders can place limit orders, the presence of market-makers leads to more effective price-discovery and greater price stability under a...

• Type: Conference
• Year: 2008
• Where: ATAL
• Authors: Sanmay Das
• Keywords: ATAL 2008, Exogenous Price Shocks, Intelligent Agents, Orderly Price Transitions, Paper Studies Price