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FX Market Maker Inventory Hedging and Exposure Control

Article Quant Q&A · Author: Tanmay
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Summary

The document asks how an FX spot market maker should manage and hedge currency inventory accumulated while providing quotes. It raises practical questions about measuring exposure, choosing hedge instruments, and deciding how frequently to rebalance while accounting for transaction costs. It does not provide a specific optimization method or compare alternative hedging schedules.

The replies point to a foreign exchange derivatives reference and a public company filing describing a market-making approach. The filing says the firm limits position sizes and hedges positions rapidly to reduce price exposure, aiming to earn spreads across many instruments and markets. This is a high-level description of one firm's risk controls rather than a detailed, independently evaluated hedging model. The performance claim is self-reported and does not establish that the approach is optimal or broadly applicable to FX spot market makers.

Key ideas

  • FX market makers must manage the currency inventory created by their trading activity.
  • Exposure measurement and hedge frequency should be considered alongside transaction costs.
  • A cited firm's approach limits notional positions and hedges rapidly to reduce price risk.
  • The document offers references and a company description, but no quantitative hedge optimization method.

Tags

ForexMarket makingRisk managementExecution
Full text
# Literature on FX market-maker hedging strategies


# Literature on FX market-maker hedging strategies












Specifically, FX market making.

I am not exactly looking for market-making strategies, but rather when once a market-maker has assumed a net position in a currency spot trading market, what are some optimal ways of hedging that position, measures of exposure, how often the hedge should be rebalanced optimizing to reduce transaction costs etc.

Any pointers to books or papers are appreciated!

## Answer by jraffaud (score 3)

https://quant.stackexchange.com/a/41009

take a look at Giles Jewitt's "FX Derivatives Trader School". A clear, concise yet exhaustive read. Highly recommend.

## Answer by zer0hedge (score 1)

https://quant.stackexchange.com/a/40559

Have a look at FORM S-1 Securities Registration Statement by Virtu Financial, Inc. as filed with the Securities and Exchange Commission on March 10, 2014:

> Virtu is a leading technology-enabled market maker and liquidity provider to the global financial markets. $\ldots$ We make markets by providing quotations to buyers and sellers in more than 10,000 securities and other financial instruments on more than 210 unique exchanges, markets and liquidity pools in 30 countries around the world.

In particular they make market in global Currencies (including futures contracts in FX) at CME, ICE, Currenex, EBS, HotSpot, Reuters, FXall and LMAX.

They describe their approach as follows:

> We refer to our market making activities as being "market neutral," which means that we are not dependent on the direction of a particular market and do not speculate. Our market making activities are designed to minimize capital at risk at any given time by limiting the notional size of our positions. Our strategies are also designed to lock in returns through precise and nearly instantaneous hedging, as we seek to eliminate the price risk in any positions held. Our revenue generation is driven primarily by transaction volume across a broad range of securities, asset classes and geographies. We avoid the risk of long or short positions in favor of earning small bid/ask spreads on large trading volumes across thousands of securities and other financial instruments. We do not engage in the types of principal investing and predictive, momentum and signal trading in which many other broker-dealers and trading firms engage.

Their results are impressive:

> The chart below illustrates our daily Adjusted Net Trading Income from January 1, 2009 through December 31, 2013. As a result of our real-time risk management strategy and technology, we had only one losing trading day during the period depicted, a total of 1,238 trading days.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

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