Paper: arXiv 2601.13421

Authors: Alexander Barzykin

Abstract

Dealers in foreign exchange markets provide bid and ask prices to their clients at which they are happy to buy and sell, respectively. To manage risk, dealers can skew their quotes and hedge in the interbank market. Hedging offers certainty but comes with transaction costs and market impact. Optimal market making with execution has previously been addressed within the Almgren-Chriss market impact model, which includes instantaneous and permanent components. However, there is overwhelming empirical evidence of the transient nature of market impact, with instantaneous and permanent impacts arising as the two limiting cases. In this note, we consider an intermediate scenario and study the interplay between risk management and impact resilience.

Complexity vs Empirical Score

  • Math Complexity: 7.0/10
  • Empirical Rigor: 3.5/10
  • Quadrant: Lab Rats — theoretically deep, empirically untested

Why this score: The paper provides a rigorous mathematical framework extending Avellaneda-Stoikov market making to transient impact via stochastic optimal control and HJB equations. While theoretical insights and numerical simulations are well-articulated, the paper lacks empirical backtesting on real tick or order book data.

Research Flowchart

  flowchart TD
    A[Research Goal: Analyze FX Market Making with Transient Impact] --> B[Input Parameters: Client Flow, Volatility, Impact Resilience Kernel]
    B --> C[Formulate Stochastic Control Problem]
    C --> D[Derive Hamilton-Jacobi-Bellman Equation]
    D --> E[Solve for Optimal Control Policy]
    E --> F[Key Outcome: Dynamic Balance of Quote Skewing vs Interbank Hedging]

Cited References (25)

  1. FX Market Making with Internal Liquidity — → 2512.04603
  2. Optimal Quoting under Adverse Selection and Price Reading — → 2508.20225
  3. Strict Universality of the Square-Root Law in Price Impact across Stocks: A Complete Survey of the Tokyo Stock Exchange. — → 2411.13965
  4. Nash equilibrium between brokers and traders — → 2407.10561
  5. The two square root laws of market impact and the role of sophisticated market participants — → 2311.18283
  6. The Cost of Misspecifying Price Impact — → 2306.00599
  7. Algorithmic market making in dealer markets with hedging and market impact (2021) — link
  8. Optimal Signal-Adaptive Trading with Temporary and Transient Price Impact (2020) — link
and 17 more
  1. Size matters for OTC market makers: General results and dimensionality reduction techniques (2019) — link
  2. Crossover from Linear to Square-Root Market Impact. (2018) — link
  3. Closed-form Approximations in Multi-asset Market Making (2018) — link
  4. Internalisation by electronic FX spot dealers (2018) — link
  5. Trades, Quotes and Prices: Financial Markets Under the Microscope (2018) — link
  6. Price Impact Without Order Book: A Study of the OTC Credit Index Market (2016) — link
  7. The Financial Mathematics of Market Liquidity : From Optimal Execution to Market Making (2016) — link
  8. Algorithmic and High Frequency Trading (2016) — link
  9. Impact of Trading in the Multi-Dealer Spot Foreign Exchange (2015) — link
  10. Buy Low, Sell High: A High Frequency Trading Perspective (2014) — link
  11. Dealing with the inventory risk: a solution to the market making problem (2011) — link
  12. Anomalous price impact and the critical nature of liquidity in financial markets (2011) — link
  13. No-dynamic-arbitrage and market impact (2010) — link
  14. High-frequency trading in a limit order book (2008) — link
  15. Optimal trading strategy and supply/demand dynamics (2013)
  16. Optimal execution for portfolio transactions (2006)
  17. Handbook of Price Impact Modeling , 2023 (

6 of 25 cited works are in the corpus; resolved via arXiv source bundles, Semantic Scholar and OpenAlex. Corpus-wide: 2518 linked papers.