Market Making and Liquidity Provision › Key Parameters
Michael BrenndoerferDecember 31, 20251 min read
Quantitative FinanceAll chapters Part 12 of 15Market Making and High-Frequency Trading
Market Making and Liquidity Provision › Key ParametersOne section · Sections in this chapter8 / 13 ↓
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The key parameters for the market making simulation are:
- S0: Initial mid price. The starting point for the asset price simulation. This anchors all price calculations and determines the dollar value of positions.
- σ: Annualized volatility (sigma). Higher volatility increases inventory risk and widens spreads. This parameter must be estimated from recent market data and updated regularly.
- γ: Risk aversion parameter (gamma). Controls how aggressively you adjust quotes to manage inventory. Higher values lead to more aggressive inventory management but potentially less competitive quotes.
- k: Order book density. Determines how quickly the probability of a fill decays as quotes move away from the mid price. This parameter captures market-specific characteristics of order flow.
- A: Baseline arrival rate (lambda_base). The expected number of orders per unit time when quoting at the mid price. This sets the overall activity level of the simulation.