Market Making in Spot Precious Metals

ArXiv ID: 2404.15478 “View on arXiv”

Authors: Unknown

Abstract

The primary challenge of market making in spot precious metals is navigating the liquidity that is mainly provided by futures contracts. The Exchange for Physical (EFP) spread, which is the price difference between futures and spot, plays a pivotal role and exhibits multiple modes of relaxation corresponding to the diverse trading horizons of market participants. In this paper, we model the EFP spread using a nested Ornstein-Uhlenbeck process, in the spirit of the two-factor Hull-White model for interest rates. We demonstrate the suitability of the framework for maximizing the expected P&L of a market maker while minimizing inventory risk across both spot and futures. Using a computationally efficient technique to approximate the solution of the Hamilton-Jacobi-Bellman equation associated with the corresponding stochastic optimal control problem, our methodology facilitates strategy optimization on demand in near real-time, paving the way for advanced algorithmic market making that capitalizes on the co-integration properties intrinsic to the precious metals sector.

Keywords: Ornstein-Uhlenbeck Process, Stochastic Optimal Control, Hamilton-Jacobi-Bellman Equation, Market Making, Exchange for Physical (EFP), Precious Metals

Complexity vs Empirical Score

  • Math Complexity: 8.5/10
  • Empirical Rigor: 4.0/10
  • Quadrant: Lab Rats
  • Why: The paper employs advanced stochastic control theory with nested Ornstein-Uhlenbeck processes, Hamilton-Jacobi-Bellman equations, and Riccati equations, indicating high mathematical density. However, the summary and excerpt focus on theoretical modeling and optimization without presenting backtested results, implementation code, or specific data, placing it in the realm of theoretical research rather than immediate practical deployment.
  flowchart TD
    A["Research Goal"] --> B["Market Making for Precious Metals"]
    B --> C["Key Challenge: Spot-Futures Liquidity Gap"]
    C --> D["Data Input: EFP Spread Time Series"]
    D --> E["Methodology: Nested Ornstein-Uhlenbeck Process"]
    E --> F["Computation: Approx. Hamilton-Jacobi-Bellman"]
    F --> G["Outcome: Optimized Strategy for P&L & Risk"]
    G --> H["Near Real-time Algorithmic Market Making"]