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A Formal Dynamic Model of Market Making

Published online by Cambridge University Press:  06 April 2009

James Bradfield
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Extract

In a recent issue of this journal Barnea [1] presented an empirical study of the impact of a specialist (market-maker) on the variability of the price of a stock. He concludes with others that “the chief cost of dealing with a market maker is the difference between the theoretical but unobservable equilibrium price and the transaction price, rather than the bid-ask spread.” This paper presents a rigorous dynamic model in which the specialist, who is uncertain about the future arrival of tenders, determines transaction prices periodically over the trading day. The structure of the model permits a direct comparison of the specialist's prices to the “equilibrium price,” to be defined below, and also to what prices would be in the absence of a specialist.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 14 , Issue 2 , June 1979 , pp. 275 - 291
Copyright
Copyright © School of Business Administration, University of Washington 1979

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References

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