Spread, Volatility, and Volume Relationship in Financial Markets and Market Maker's Profit Optimization
31 Pages Posted: 26 Jun 2016 Last revised: 18 Jul 2016
Date Written: June 23, 2016
We study the relationship between price spread, volatility and trading volume. We find that spread forms as a result of interplay between order liquidity and order impact. When trading volume is small adding more liquidity helps improve price accuracy and reduce spread, but after some point additional liquidity begins to deteriorate price. The model allows to connect the bid-ask spread and high-low bars to measurable microstructural parameters and express their dependence on trading volume, volatility and time horizon. Using the established relations, we address the operating spread optimization problem to maximize the market-maker’s profit.
Keywords: Market making, market microstructure, price measurement, quantitative trading, volatility, spread, finance, physics of financial markets
JEL Classification: G12, C44, C51
Suggested Citation: Suggested Citation