Intraday Market Making with Overnight Inventory Costs

Journal of Financial Markets, Forthcoming

65 Pages Posted: 29 Sep 2016 Last revised: 13 Apr 2020

See all articles by Tobias Adrian

Tobias Adrian

International Monetary Fund

Agostino Capponi

Columbia University

Michael J. Fleming

Federal Reserve Bank of New York

Erik Vogt

Citadel LLC

Hongzhong Zhang

Columbia University

Multiple version iconThere are 3 versions of this paper

Date Written: April 12, 2020

Abstract

The U.S. Treasury market is highly intermediated by non-bank principal trading firms (PTFs). Limited capital forces PTFs to end the trading day nearly flat. We construct a continuous time market making model to analyze the trade-off faced by a profit maximizing firm with overnight inventory costs, and develop closed-form representations of the optimal price policy functions. Our model reveals that bid-ask spreads widen as the end of the trading day approaches, and that increases in order arrival rates do not always lead to higher price volatility. Our empirical analysis shows that Treasury security trading costs increase as the close of trading approaches, consistent with model predictions.

Keywords: inventory control, jump-driven stochastic control, market microstructure theory, market making

JEL Classification: G12, G17, G01

Suggested Citation

Adrian, Tobias and Capponi, Agostino and Fleming, Michael J. and Vogt, Erik and Zhang, Hongzhong, Intraday Market Making with Overnight Inventory Costs (April 12, 2020). Journal of Financial Markets, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2844881 or http://dx.doi.org/10.2139/ssrn.2844881

Tobias Adrian

International Monetary Fund ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

HOME PAGE: http://www.tobiasadrian.com

Agostino Capponi (Contact Author)

Columbia University ( email )

S. W. Mudd Building
New York, NY 10027
United States

Michael J. Fleming

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States
212-720-6372 (Phone)
212-720-1582 (Fax)

HOME PAGE: http://www.newyorkfed.org/research/economists/fleming/

Erik Vogt

Citadel LLC ( email )

131 S Dearborn Street
Chicago, IL 60603
United States

Hongzhong Zhang

Columbia University ( email )

3022 Broadway
New York, NY 10027
United States

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