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The Sneaky, the sleepy and the skeptic: a behavioral model of market making: evidence of strategic market making on the treasury bond market

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The authors study the behavior of market makers in the Treasury bond market, by using a unique dataset that allows them to observe market makers' strategies jointly on the primary and secondary markets. They show that market makers actively learn from the dealers they are treading with. This allows them to react strategically to the information content of the orders they receive. Unlike the standard inventory or asymmetric information models, we allow market makers to place orders directly with other market makers. The authors identify two main types of strategic reaction to the informational content of trade: "hiding" and "experimenting". They show that all the market makers can be grouped into three classes (the sneakies, the sleepies and the skeptics), depending on their strategies. In particular, some market makers selectively choose the other market makers they place orders with in order to minimize the price impact of their trade. Others, on the contrary, choose their counterparts so as to learn the true quality of their information by observing the way they react to their trade. The choice of the type of strategy depends on the market makers' priors regarding the degree of informativeness of the other market makers they are dealing with. The authors also show that the information acquired by trading in the secondary market affects market makers' behavior in the primary market. Bidding aggressiveness and dispersion of bids are a function of market makers' learning.

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en

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application/pdf

Resource resource URL

http://flora.insead.edu/fichiersti_wp/inseadwp2000/2000-39.pdf

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Copyright INSEAD. All rights reserved