Leaning Against the Wind

Weill, Pierre-Olivier

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Leaning Against the Wind

NYU Working Paper No. FIN-05-017

67 Pages Posted: 3 Nov 2008

See all articles by Pierre-Olivier Weill

Pierre-Olivier Weill

University of California, Los Angeles; National Bureau of Economic Research (NBER)

There are 2 versions of this paper

Date Written: February 2005

Abstract

During financial disruptions, market makers provide liquidity by absorbing external selling pressure. They buy when the pressure is large, accumulate inventories, and sell when the pressure alleviates. This paper studies optimal dynamic liquidity provision in a theoretical market setting with large and temporary selling pressure, and order-execution delays. I show that competitive market makers offer the socially optimal amount of liquidity, provided they have access to sufficient capital. If raising capital is costly, this suggests a policy role for lenient central bank lending during financial disruptions.

Keywords: Market making capital, market maker inventory management

Suggested Citation: Suggested Citation

Weill, Pierre-Olivier, Leaning Against the Wind (February 2005). NYU Working Paper No. FIN-05-017, Available at SSRN: https://ssrn.com/abstract=1294153