Market Making with Asymmetric Information, Inventory Risk and Imperfect Competition∗
نویسندگان
چکیده
Existing microstructure literature cannot explain the empirical evidence that bid-ask spreads can decrease with information asymmetry and ignores either information asymmetry or inventory risks. We develop a market making model that highlights the asset pricing impact of market makers’ capability of making offsetting trades in markets where both information asymmetry and inventory risk are significant (e.g., Over-the-Counter markets). We solve equilibrium bid/ask prices and depths, and equilibrium trading volume in closed-form. We show that this model can help explain the bid-ask spread puzzle and also propose a new measure of information asymmetry. JEL Classification Codes: D42, D53, D82, G12, G18.
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