Avellaneda–Stoikov Market Making with Inventory Skew and Liquidity Estimates

Summary

This description explains a limit-order market-making strategy based on the Avellaneda–Stoikov framework. It sets a reservation price and optimal bid-ask spread using estimated volatility, order-book liquidity, inventory relative to a target allocation, the trading horizon, and a risk-aversion parameter. Inventory imbalance moves the reservation price away from the mid price so that orders on the side that reduces unwanted inventory are more likely to fill. A separate order-size adjustment can also make bid and ask quantities asymmetric.

The strategy estimates volatility and trading intensity from buffered market observations, and can place multiple order levels around the optimal prices. A minimum spread acts as a threshold for whether orders are placed, while the risk parameter affects both inventory skew and spread behavior. The description warns that extreme settings can produce invalid prices and that the estimators need enough observations before trading begins. It calls itself an approximation and directs readers to inspect implementation details; it provides no performance evidence, and parameter effects require asset-specific experimentation.

Key ideas

• The strategy derives a reservation price and optimal spread from volatility, liquidity, inventory, time horizon, and risk aversion.
• Inventory imbalance skews quotes toward the side that helps move holdings toward a target allocation.
• Order size and layered price levels can further shape inventory adjustment and quote placement.
• Volatility and trading-intensity estimates require a buffer of valid observations before orders can begin.
• Parameter settings can yield unusable quotes, and the documentation offers no performance validation.

Tags

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.