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Risk-Averse Market Maker And Supply Of Liquidity, Suren Basov, Xiangkang Yin
Risk-Averse Market Maker And Supply Of Liquidity, Suren Basov, Xiangkang Yin
Suren Basov
In this paper we modify Biais, Martimort, and Rochet (2000) model to allow risk aversion on the side of the market maker. In formulated the model we build on the model of optimal screening by a risk-averse principal, developed by Basov and Yin (2010). We characterize the optimal contract and show that risk aversion on the market maker side increases non-participation range by the agent and the bid-ask spread. Risk aversion also increases trading volumes and decreases market maker profits, decreasing possibilities of potential entry of competing money makers.