On the Existence of Linear Equilibria in Models of Market Making |
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Authors: | Mark Bagnoli S Viswanathan & Craig Holden |
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Institution: | Krannert Graduate School of Management, Purdue University,;Fuqua School of Business, Duke University,;Finance Department, Indiana University |
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Abstract: | We derive necessary and sufficient conditions for a linear equilibrium in three types of competitive market making models: Kyle type models (when market makers only observe aggregate net order flow), Glosten–Milgrom and Easley–O'Hara type models (when market makers observe and trade one order at a time), and call markets models (individual order models when market makers observe a number of orders before pricing and executing any of them). We study two cases: when privately informed (strategic) traders are symmetrically informed and when they have differential information. We derive necessary and sufficient conditions on the distributions of the random variables for a linear equilibrium. We also explore those features of the equilibrium that depend on linearity as opposed to the particular distributional assumptions and we provide a large number of examples of linear equilibria for each of the models. |
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Keywords: | market microstructure market making strategic trading linear equilibria |
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