Author(s)

Hervé Boco¹, Laurent Germain¹, Fabrice Rousseau²

¹Toulouse Business School, University of Toulouse, Toulouse, France.
²Department of Economics, Finance and Accounting, Maynooth University, County Kildare, Ireland.

We analyze the result of allowing a risk averse trader to split his order among risk averse market makers. We find that the market makers’ aggregate expected utility of profit can increase with the number of market markers and that the aggregate liquidity always increases with it. Despite this latter finding, we show that the cost of trading for the traders increases with the number of market makers as measured by their aggregate expected utility of profit. The larger the market makers’ risk aversion, the bigger that cost is. We also find that when the number of market makers tends to infinity, their aggregate expected utility of profit tends to zero. We also obtain that the market makers’ individual and aggregate expected utility of profit can increase with their risk aversion and that the trader’s expected utility of profit can increase or decrease with the market makers’ risk aversion. We offer a potential answer to the ongoing debate concerning the dealers’ competitiveness. Indeed, risk aversion reduces competition between market makers as it acts as a commitment for market makers to set higher prices. This commitment is higher the higher the risk aversion.

Risk Aversion, Strategic Market Makers, Strategic Traders, Splitting Orders

Boco, H. , Germain, L. and Rousseau, F. (2017) Strategic Market Making and Risk Sharing. Journal of Mathematical Finance, 7, 144-179. doi: 10.4236/jmf.2017.71008.