Risk sharing in time-priority markets

Western Finance Association Paper 2022

39 Pages Posted: 20 Jan 2022 Last revised: 4 Apr 2022

See all articles by Corey Garriott

Corey Garriott

TMX Group

Vincent van Kervel

Pontifical Catholic University of Chile

Marius Zoican

University of Toronto at Mississauga - Department of Management; University of Toronto - Rotman School of Management

Date Written: March 29, 2022

Abstract

We document low cross-sectional correlations between market maker (MM) inventory positions in Canadian futures markets, suggesting imperfect risk sharing. We build a model to understand how cross-sectional heterogeneity in inventories shapes liquidity provision in time-priority markets. The optimal limit order size depends on inventory, which in turn affects successors' queue positions and adverse selection risk. Depth is maximized (minimized) if large inventory MMs arrive early (late) in the queue. Empirically, this effect explains 8% of depth variability in our sample. Further, our model allows us to cleanly distinguish between inventory frictions and adverse selection using quote sizes.

Keywords: limit order markets, time priority, risk sharing, adverse selection, inventory risk

JEL Classification: G11, G12, G14

Suggested Citation

Garriott, Corey and van Kervel, Vincent and Zoican, Marius, Risk sharing in time-priority markets (March 29, 2022). Western Finance Association Paper 2022, Available at SSRN: https://ssrn.com/abstract=3991930 or http://dx.doi.org/10.2139/ssrn.3991930

Corey Garriott

TMX Group ( email )

130 King St W
Toronto, Ontario M5X 2A2
Canada

Vincent Van Kervel

Pontifical Catholic University of Chile ( email )

Av Libertador General Bernardo O'Higgins 340
Santiago, Región Metropolitana 8331150
Chile

Marius Zoican (Contact Author)

University of Toronto at Mississauga - Department of Management ( email )


Canada

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada

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

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