Price Discovery and Risk Controls for Thinly Traded Market Making
Summary
The discussion considers how to make markets in assets with sparse trading, few resting orders, limited participants, high volatility, and wide spreads. Suggested price-discovery inputs include researching who holds the asset, identifying historical buyers and likely buying or selling levels, and using customer limit orders and tape prints to estimate the inside market. The advice is to show smaller size near the inside while keeping capacity to provide larger liquidity at wider prices, and to watch for short-term price dislocations.
The replies also point to research on dealer pricing when transactions and returns are uncertain, and to secondary-market information as a possible aid to valuation. These are suggestions rather than a tested strategy: the discussion provides no performance data or detailed algorithm for inferring fair value or detecting predatory order flow. It cautions that inventory and regulatory obligations can make unborrowable short positions especially consequential. Applicability will depend on the asset, available ownership data, and the trader’s specific market-making obligations.
Key ideas
- Research holders and historical buyers to identify likely areas of supply and demand.
- Use customer limit orders and trade prints as reference points for the inside market.
- Consider displaying smaller size near the inside and reserving larger liquidity for wider prices.
- Short-term price dislocations may create opportunities, but the discussion gives no tested detection method.
- Account for inventory exposure and obligations when short positions cannot be borrowed.
Tags
Full text
# Market making in thinly traded assets # Market making in thinly traded assets Could anyone suggest some literature or have any practical advice for marking a market in thinly traded assets with the following characteristics: - 0-10 trades per day. - Open limit-order book with 0-5 resting orders. - Almost no correlation with more liquid assets - Relatively high volatility. - Small number of market participants. - Very wide spreads that will hopefully make the risk worthwhile. I am most interested in price discovery. How should I best use the limited information available and how should I protect myself against predatory traders who may take advantage of my algorithms by moving the market? ## Answer by Sammy (score 3) https://quant.stackexchange.com/a/20982 Research where the liquidity is, Who are the holders and who have historically been the buyers. Getting insight who the buyers and at what price level they would sell (or buy more) is a good technique. Often time ownership information is available to the public information. Once you figure out such levels then you know the price levels you can provide larger sized liquidity. Customer limit orders and prints on the tape can help benchmark your inside. You will want to consider displaying smaller size at narrower prices but have the capability to provide larger sized liquidity wider than the inside. Look for short term dislocation of prices can bring profit opportunities. Be careful if you have firm risk obligations and/or regulatory obligations to cover short positions that you can not borrow (such as SEC's reg SHO for equity short positions). ## Answer by tfb (score 0) https://quant.stackexchange.com/a/19459 There's a decent amount of literature about market making under uncertainty, one just needs to look. Start with the below and then use this title as a search for other relevant articles, it's cited a lot: - Optimal Dealer Pricing Under Transactions and Return Uncertainty ## Answer by jeff m (score -2) https://quant.stackexchange.com/a/3867 This might not be as thinly traded as your looking for, but SharesPost might have some useful information for you, at least on the price discovery part.
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.