Paper: arXiv 2409.16589

Abstract

This paper conducts an empirical investigation into the effects of Designated Market Makers (DMMs) on key market quality indicators, such as liquidity, bid-ask spreads, and order fulfillment ratios. Through agent-based simulations, this study explores the impact of varying competition levels and incentive structures among DMMs on market dynamics. It aims to demonstrate that DMMs are crucial for enhancing market liquidity and stabilizing price spreads, thereby affirming their essential role in promoting market efficiency. Our findings confirm the impact of the number of Designated Market Makers (DMMs) and asset diversity on market liquidity. The result also suggests that an optimal level of competition among DMMs can maximize liquidity benefits while minimizing negative impacts on price discovery. Additionally, the research indicates that the benefits of increased number of DMMs diminish beyond a certain threshold, implying that excessive incentives may not further improve market quality metrics.

Complexity vs Empirical Score

  • Math Complexity: 6.0/10
  • Empirical Rigor: 8.0/10
  • Quadrant: Holy Grail — high math complexity, high empirical rigor

Why this score: The paper uses an agent-based simulation with defined statistical distributions (Poisson, Brownian Motion) and metrics, indicating moderate mathematical complexity. Its high empirical rigor comes from implementing a coded simulation platform (Python, GitHub), varying multiple parameters, and analyzing numerous backtest-ready metrics like spreads, depth, and realized spreads.

Research Flowchart

  flowchart TD
  A["Research Goal:<br>How do DMMs impact market<br>liquidity and competition?"] --> B["Methodology:<br>Agent-Based Simulation"]
  B --> C["Data/Inputs:<br>Simulated General Markets<br>with Varying DMM Levels &<br>Asset Diversity"]
  C --> D["Computational Process:<br>Simulate Trading, Vary Competition<br>& Incentives, Measure Metrics"]
  D --> E{"Outcomes/Findings"}
  E --> F["Liquidity & Efficiency<br>Increased by DMMs"]
  E --> G["Optimal Competition<br>Maximizes Liquidity"]
  E --> H["Diminishing Returns<br>beyond threshold"]