LIQUIDITY PROVISION IN CAPACITY-CONSTRAINED MARKETS
We study a competitive dynamic financial market subject to a transient selling pressure when market makers face a capacity constraint on their number of trades per unit of time with outside investors. We show that profit-maximizing market makers provide liquidity in order to manage their trading capacity constraint optimally over time: they use slack trading capacity early to accumulate assets when the selling pressure is strong in order to relax their trading capacity constraint and sell to buyers more quickly when the selling pressure subsides. When the trading capacity constraint binds, the bid–ask spread is strictly positive, widening and narrowing as market makers build up and unwind their inventories. Because the equilibrium asset allocation is constrained Pareto-optimal, the time variations in bid–ask spread are not a symptom of inefficient liquidity provision.
Year of publication: |
2011
|
---|---|
Authors: | Weill, Pierre-Olivier |
Published in: |
Macroeconomic Dynamics. - Cambridge University Press. - Vol. 15.2011, S1, p. 119-144
|
Publisher: |
Cambridge University Press |
Description of contents: | Abstract [journals.cambridge.org] |
Saved in:
Saved in favorites
Similar items by person
-
A tractable model of monetary exchange with ex-post heterogeneity
Rocheteau, Guillaume, (2018)
-
Heterogeneity in decentralized asset markets
Hugonnier, Julien, (2022)
-
A search-based theory of the on-the-run phenomenon
Vayanos, Dimitri, (2008)
- More ...