Intraday Market Making with Overnight Inventory Costs

57 Pages Posted: 25 Oct 2016

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: March 2020

Abstract

The U.S. Treasury market is highly intermediated by nonbank principal trading firms (PTFs). Limited capital forces PTFs to end the trading day roughly 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: market microstructure theory, market liquidity, market making, financial intermediation

JEL Classification: G12, G17, G23

Suggested Citation

Adrian, Tobias and Capponi, Agostino and Fleming, Michael J. and Vogt, Erik and Zhang, Hongzhong, Intraday Market Making with Overnight Inventory Costs (March 2020). FRB of NY Staff Report No. 799, Available at SSRN: https://ssrn.com/abstract=2857535

Tobias Adrian (Contact Author)

International Monetary Fund ( email )

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

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

Agostino Capponi

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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