Inventory risk management
In the process of fulfilling their obligations, the most ideal situation is that the two-way trading volume generated by the two-way quotation is exactly the same, and a stable spread income is obtained. In this case, the market maker must be profitable as far as this transaction is concerned. But it is difficult to do it in actual transactions. If it is a unilateral transaction or the number of transactions between the two parties is different, there will be a certain amount of inventory securities (for futures, it is a one-way position), which will produce inventory risk, that is, the risk of changes in the value of positions caused by the uncertainty of securities prices. Generally speaking, the greater the volatility of stock returns and the greater the price elasticity, the greater the stock risk faced by market makers. For a specific market maker, the lower the capital adequacy ratio, the greater the sensitivity to risk, and the greater the impact of inventory risk.
The existence of inventory risk makes inventory management an important daily business content of market makers.
One of the management methods is to maintain an appropriate inventory position in continuous transactions. The appropriateness of its quantity is determined by the ability of market makers to take risks and the judgment of securities price trends. It is this inventory risk and its management that promotes the trading enthusiasm of market makers and gives the market an internal force that tends to be strong. This is also the main reason why market makers will also have a certain impact on market prices in the process of inventory management.
The second way to manage inventory risk is the extensive use of credit trading mechanism, that is, in order to manage inventory positions, market makers not only use price fluctuation leverage to deal with it, but also make inventory meet the requirements of continuous trading and cost reduction through financing and securities credit trading.
The third and most important way to manage inventory risk is to make portfolio investment and hedging by making derivative markets of securities. For stocks, market makers can use stock index futures and stock options to lock in risks.
Therefore, market makers often determine the stock of securities on the basis of comprehensive consideration of price trend, own capital, financing ability, number and structure of market participants and other factors. In general, the relationship between market makers' inventory and related factors is that inventory quantity is positively related to inventory risk. If the inventory is large, the risk will be great; Inventory has the greatest correlation with price changes. When there is an expectation of price increase, the inventory increases, and conversely, the inventory decreases (this applies to stocks and bonds, not futures). However, when the price is really at a high level, the inventory will often decrease, otherwise the inventory purchased at a high price will tend to depreciate with the decline of the market price, and the inventory risk will increase. Therefore, in order to reduce this risk, market makers tend to reduce the inventory of securities with large price increases, so in this sense, inventory is negatively related to securities prices. In addition, there is a positive correlation between inventory and market makers' own funds.
Information asymmetry risk management
Information cost includes at least two kinds, one is the cost of collecting information, and the other is the relative cost caused by information asymmetry, which is actually an opportunity cost. The information cost of market makers analyzed here is the latter. Once the market maker quotes. This means that he can trade a certain amount of securities with other members of the public at this price. However, limited by the scope and ability of information search, market makers may be "deceived" by traders with more updated information. For example, if a public trader has information that can make the real market price higher than the market maker's selling price, but the market maker doesn't understand it, he still sells securities at a relatively low price set by himself. Then, this market maker will have a "relative loss", which is the information asymmetry cost faced by market makers.
In fact, the information asymmetry risk faced by market makers is a kind of risk that is difficult to be accurately measured, and can only be measured in the price changes after engaging in it, that is, this cost is equal to the difference between the market maker's quotation and the new market price. In this way, market makers can only reduce the negative impact of asymmetric information trading by expanding the bid-ask spread, but if the spread is too large, it will also reduce the liquidity of the market, reduce the trading volume and reduce the income of market makers.
The size of asymmetric information risk is closely related to the maturity of the market, the soundness of policies and the self-discipline of traders. In the imperfect market in the primary stage, this risk will be even greater if the scope and effectiveness of the policy system are not very strong and the self-discipline awareness of market participants is poor. Therefore, in order to fundamentally reduce the overall level of information asymmetry risk, we must establish and improve an effective information disclosure system. This point should be paid special attention to when implementing the market maker system in the domestic futures market.