Market making with discrete prices
Document Type
Article
Publication Title
Review of Financial Studies
Abstract
Exchange-mandated discrete pricing restrictions create a wedge between the underlying equilibrium price and the observed price. This wedge permits a competitive market maker to realize economic profits that could help recoup fixed costs. The optimal tick size that maximizes the expected profits of the market maker can be equal to $1/8 for reasonable parameter values. The optimal tick size is decreasing in the degree of adverse selection. Discreteness per se can cause time-varying bid-ask spreads, asymmetric commissions, and market breakdowns. Discreteness, which imposes additional transaction costs, reduces the value of private information. Liquidity traders can benefit under certain conditions.
DOI Link
Publication Date
1-4-1998
Publisher
Oxford University Press
Volume
Vol.11
Issue
Iss.1
Recommended Citation
Anshuman, V Ravi and Kalay, Avner, "Market making with discrete prices" (1998). Faculty Publications. 1365.
https://research.iimb.ac.in/fac_pubs/1365
