Intraday Market Making with Overnight Inventory Costs

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: 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