Liquidity Supply by a Risk‐Averse Market Maker

12 Pages Posted: 13 Nov 2011

See all articles by Suren Basov

Suren Basov

University of Melbourne - Department of Economics

Xiangkang Yin

Deakin University; Financial Research Network (FIRN)

Date Written: December 2011

Abstract

Market makers bear enormous uncertainty of the values of their portfolios and their attitude towards risk should not be completely ignored. In this article, we analyse a quote‐driven market of a risky financial asset, where a risk‐averse market maker supplies liquidity to traders. We characterise the equilibrium of the market for trading based on liquidity demand/diverse opinions on the value of the risky asset or based on information asymmetry. We find that risk aversion of the market maker is likely to increase the non‐participation range of traders and the bid‐ask spread.

JEL Classification: D82, G12

Suggested Citation

Basov, Suren and Yin, Xiangkang, Liquidity Supply by a Risk‐Averse Market Maker (December 2011). Economic Record, Vol. 87, Issue 279, pp. 617-628, 2011. Available at SSRN: https://ssrn.com/abstract=1958468 or http://dx.doi.org/10.1111/j.1475-4932.2011.00761.x

Suren Basov (Contact Author)

University of Melbourne - Department of Economics ( email )

Australia

Xiangkang Yin

Deakin University ( email )

Melbourne, Victoria
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

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