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The Optimal Pricing Policy of a Monopolistic Marketmaker in the Equity Market
Author(s) -
MILDENSTEIN ECKART,
SCHLEEF HAROLD
Publication year - 1983
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/j.1540-6261.1983.tb03637.x
Subject(s) - transaction cost , ask price , bid price , monopolistic competition , equity (law) , bid–ask spread , economics , portfolio , order (exchange) , microeconomics , position (finance) , dynamic programming , market maker , econometrics , market liquidity , financial economics , monetary economics , finance , mathematical optimization , monopoly , mathematics , political science , law , paleontology , horse , stock market , biology
This paper presents a stochastic optimization model for marketmaking in security markets with a single dealer. Buy and sell orders are assumed to arrive at rates that are functions of the ask and bid prices. The dealer incurs both proportional and fixed transaction costs as well as portfolio costs. Methods of dynamic programming and semi‐Markov Decision Processes are used to characterize optimal pricing policies and to perform sensitivity analysis. Both bid and ask prices are nonincreasing functions of the dealer's inventory. Spread is unrelated to inventory position but positively related to order size. Computational examples demonstrate various results.