Inventory Effects of Two Risk-Averse Market Makers

Abstract

The inventory positions of two risk-averse market makers are introduced into a Kyle (1985) type batch trading model and the effects analyzed. An equilibrium is defined including participation constraints and incentive compatibility and is characterized as a γ-coalitional equilibrium. At equilibrium, the two market makers share the risk of clearing orders so that the aggregate pricing schedule becomes linear. The pricing schedule coincides with the regret-free pricing of a fictitious risk-averse market maker. The inventories shift the pricing schedule vertically, and the coalition parameter changes the slope. Orders by the informed trader are then found to depend on inventories.