Market Making and Liquidity Provision › Market Making and Liquidity Provision

Financial markets require participants willing to stand ready to buy and sell at any moment. You fulfill this role by continuously posting bid and ask quotes, and gives liquidity to traders who need immediate execution. In exchange for this service, you capture the bid-ask spread, the difference between the price at which you buy and the price at which you sell.

Modern market making has evolved from human specialists on exchange floors to sophisticated algorithmic systems that quote across thousands of instruments simultaneously. You use mathematical models to determine optimal quote placement, manage inventory risk, and protect against informed traders. The business model is deceptively simple: buy at the bid, sell at the ask, pocket the spread. But the execution is extraordinarily complex, requiring real-time risk management, microsecond-level technology, and deep understanding of market dynamics.

This chapter explores the economics of market making, the mathematical models that guide quoting decisions, and the key risks you face. We will build a simulation framework to understand how these strategies work in practice and examine why speed and risk management are critical to success.