Market making and mean reversion

Market making and mean reversion (2011)

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by Tanmoy Chakraborty , Michael Kearns

Venue:	In Proc. ACM Conf. on Elec. Commerce
Citations:	2 - 1 self

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Datum	Value	Source
TITLE	Market making and mean reversion	INFERENCE
AUTHOR NAME	Tanmoy Chakraborty	SVM HeaderParse 0.2
AUTHOR AFFIL	University of Pennsylvania	SVM HeaderParse 0.2
AUTHOR NAME	Michael Kearns	SVM HeaderParse 0.2
AUTHOR AFFIL	University of Pennsylvania	SVM HeaderParse 0.2
ABSTRACT	Market making refers broadly to trading strategies that seek to profit by providing liquidity to other traders, while avoiding accumulating a large net position in a stock. In this paper, we study the profitability of market making strategies in a variety of time series models for the evolution of a stock’s price. We first provide a precise theoretical characterization of the profitability of a simple and natural market making algorithm in the absence of any stochastic assumptions on price evolution. This characterization exhibits a trade-off between the positive effect of local price fluctuations and the negative effect of net price change. We then use this general characterization to prove that market making is generally profitable on mean reverting time series — time series with a tendency to revert to a long-term average. Mean reversion has been empirically observed in many markets, especially foreign exchange and commodities. We show that the slightest mean reversion yields positive expected profit, and also obtain stronger profit guarantees for a canonical stochastic mean reverting process, known as the Ornstein-Uhlenbeck (OU) process, as well as other stochastic mean reverting series studied in the finance literature. We also show that market making remains profitable in expectation for the OU process even if some realistic restrictions on trading frequency are placed on the market maker.	SVM HeaderParse 0.2
YEAR	2011	INFERENCE
VENUE	In Proc. ACM Conf. on Elec. Commerce	INFERENCE
VENUE TYPE	CONFERENCE	INFERENCE
CITATIONS	14 found	ParsCit 1.0