Market makers activity: behavioural and agent based approach

Abstract

The goal of this paper is to verify how behavioural and social features influence the decisions of market makers and to identify the impact that such decisions have on the trade volume, price levels and bid-ask spreads observed in the market. Many classical microstructural models explain the rational behaviour of market makers. We can distinguish two main groups of such models: information-based models and inventory-based ones. On the one hand, information-based models emphasise the role of the informational asymmetry between market makers and informed traders. On the other hand, inventory-based models relate the behaviour of market makers to the current status of inventories. In particular, the objective of the market maker is to either avoid bankruptcy or merely maintain an inventory balance. It is known, however, that it is not just rational factors which may influence economic behaviour. In particular, based on the literature, we stipulate that such personal traits as risk attitude, impulsivity, social behaviour and sense of fairness may influence market makers’ behaviour. To verify this, we conducted a series of experiments with the goal of analysing the relation between these factors and market maker behaviour. Participants in these experiments played the role of a market maker in the simulated options market. Experimental data enabled us to analyse how the behavioural traits influence individual decisions. However, due to missing interactions among market makers during the experiment, the data did not enable us to analyse how these traits influence the aggregated observed markets parameters, such as trading volume and mean spread in a competitive market. Therefore, we propose a formal agent-based model that makes it possible to investigate how behavioural factors influence market variables such as price and volume by means of the simulation.