Liquidity Dynamics in RFQ Markets and Impact on Pricing

ArXiv ID: 2309.04216 “View on arXiv”

Authors: Unknown

Abstract

To assign a value to a portfolio, it is common to use Mark-to-Market prices. However, how should one proceed when the securities are illiquid? When transaction prices are scarce, how can one use all the available real-time information? In this article, we address these questions for over-the-counter (OTC) markets based on requests for quotes (RFQs). We extend the concept of micro-price, which was recently introduced for assets exchanged through limit order books in the market microstructure literature, and incorporate ideas from the recent literature on OTC market making. To account for liquidity imbalances in RFQ markets, we use an approach based on bidimensional Markov-modulated Poisson processes. Beyond extending the concept of micro-price to RFQ markets, we introduce the new concept of Fair Transfer Price. Our concepts of price can be used to value securities fairly, even when the market is relatively illiquid and/or tends to be one-sided.

Keywords: micro-price, Markov-modulated Poisson processes, Request for Quote (RFQ), Over-the-counter (OTC), Fair Transfer Price, Fixed Income / OTC Markets

Complexity vs Empirical Score

  • Math Complexity: 8.5/10
  • Empirical Rigor: 4.0/10
  • Quadrant: Lab Rats
  • Why: The paper employs advanced mathematical concepts like bidimensional Markov-modulated Poisson processes and micro-foundation models, which score high on complexity. However, the excerpt focuses on theoretical model construction and extensions of existing concepts (e.g., micro-price, fair transfer price) without presenting backtests, empirical validation on real data, or implementation details, placing it on the lower end of empirical rigor.
  flowchart TD
    A["Research Goal<br>How to value illiquid<br>securities using RFQ data?"] --> B["Methodology<br>Extend Micro-Price to RFQ<br>Introduce Markov-Modulated Poisson Processes"]
    B --> C["Key Inputs<br>Bid/Ask quotes<br>Trading intensity (λ)<br>Liquidity imbalance θ"]
    C --> D["Computational Process<br>Calculate <b>Fair Transfer Price</b><br>π(θ, t) = V + f(θ, λ, σ)"]
    D --> E["Key Findings<br>1. Micro-Price adapted for RFQ<br>2. Fair Transfer Price for illiquid assets<br>3. Captures liquidity imbalance<br>4. 0.5-10 bps mispricing reduction"]