Market making with alpha signals

Author: 

Cartea, A
Wang, Y

Publication Date: 

16 May 2020

Journal: 

International Journal of Theoretical and Applied Finance

Last Updated: 

2021-06-12T23:35:27.983+01:00

Issue: 

3

Volume: 

23

DOI: 

10.1142/S0219024920500168

abstract: 

We show how a market maker employs information about the momentum in the price of the asset (i.e. alpha signal) to make decisions in their liquidity provision strategy in an order-driven electronic market. The momentum in the midprice of the asset depends on the execution of liquidity taking orders and the arrival of news. Buy market orders (MOs) exert a short-lived upward pressure on the midprice, whereas sell MOs exert a short-lived downward pressure on the midprice. We employ Nasdaq high-frequency data to estimate model parameters and to illustrate the performance of the market making strategy. The market maker employs the alpha signal to minimise adverse selection costs, execute directional trades in anticipation of price changes, and to manage inventory risk. As the market maker increases their tolerance to inventory risk, the expected profits that stem from the alpha signal increase because the strategy employs more speculative MOs and performs more roundtrip trades with limit orders.

Symplectic id: 

1088249

Submitted to ORA: 

Submitted

Publication Type: 

Journal Article