Automated Liquidity Provision
42 Pages Posted: 15 Jul 2010 Last revised: 20 Jan 2015
Date Written: December 1, 2014
Traditional market makers are losing their importance as automated systems have largely assumed the role of liquidity provision in markets. We update the model of Glosten and Milgrom (1985) to analyze this new world: we add multiple securities and introduce an automated market maker who prices order flow for all securities contemporaneously. This automated participant transacts the majority of orders, sets prices that are more efficient, increases informed and decreases uninformed traders' transaction costs, and has no effect on volatility. The model's predictions match very well with recent empirical findings and are difficult to replicate with alternative models.
Keywords: Algorithmic Trading, Automated Trading, High Frequency Trading, Market Making, Specialist, Statistical Arbitrage
JEL Classification: G14, G19
Suggested Citation: Suggested Citation