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On the Feasibility of Automated Market Making by a Programmed Specialist
Author(s) -
HAKANSSON NILS H.,
BEJA AVRAHAM,
KALE JIVENDRA
Publication year - 1985
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.1540-6261.1985.tb04934.x
Subject(s) - smoothing , classification of discontinuities , aggregate demand , aggregate (composite) , order (exchange) , limit (mathematics) , point (geometry) , intervention (counseling) , supply and demand , computer science , simple (philosophy) , economics , microeconomics , finance , mathematics , monetary economics , monetary policy , mathematical analysis , psychology , philosophy , materials science , geometry , epistemology , psychiatry , composite material , computer vision
Securities trading is accomplished through the execution of orders. Admissible orders (e.g., market orders, limit orders) give rise to discontinuous aggregate demand functions, composed of many “steps.” Demand smoothing , or the balancing of excesses due to such discontinuities via intervention, is one of the most basic functions that could be assigned to a “specialist.” When the specialist's “affirmative obligation” is fully specified, his or her activity can in principle be automated. This paper is an attempt to assess, via simulation, some of the ramifications of using a “programmed specialist,” whose automated market making is limited to demand smoothing. A number of alternative rules of operation are simulated. Several of the rules performed well, especially the extremely simple rule that calls for the (computerized) specialist to minimize new absolute share holdings in each security at each trading point via “total” (as opposed to “local”) demand smoothing. Our results indicate that the underlying costs of demand smoothing are on the order of a fraction of a penny per share traded even in relatively thin markets.