Dynamic Market Making with Asymmetric Information and Market Power

We study the dynamics of bid-ask spread and trading volume using a multi-period trading model with asymmetric information and oligopolistic market makers. Market makers optimally make offsetting trades in "bid" and "ask" markets by adjusting bid and ask prices/depths to avoid holding inventories. We find that when market makers have significant market power, other traders optimally smooth out their trading even though they are not strategic. Consequently, trading persists even after arrivals of information and liquidity shocks. Traders trade quickly to compete on their private information while postponing their hedging trades until later periods. As a result, both trading volume and bid-ask spread may exhibit U-shaped patterns. More trading rounds mitigate market makers' market power, and thus decrease bid and ask spreads and increase total trading volume. Therefore, while a higher trading frequency benefits traders, it may hurt market makers