Market making, prices, and quantity limits

This article develops a model of spread and depth setting underasymmetric information where the equilibrium depth is proportionallymore sensitive than the spread to changes in the degree of informationasymmetry. The analysis uses a one-period model in which a risk-neutral,monopolistic market maker faces a price-sensitive liquiditytrader and a better informed trader who is alternatively riskneutral and risk averse. The equilibrium depth can take valuesranging from 0 to infinity, depending on the information asymmetry,the asset volatility, and the strength of the liquidity demand,while the spread remains positive and finite.