Incentivising Market Making in Financial Markets

In their pursue for profit, market makers contribute liquidity and thus play a fundamental role for the health of financial markets. The mechanism used to rank bids and asks in order-driven markets can influence trader behaviour and discourage market making, with obvious consequences on market fundamentals. This is the rationale behind market trading mechanisms, which assign weight to both the spread of two-sided orders and order prices. In this work, we assess the effectiveness of this proposal from a game-theoretic standpoint. We use strategic agents and explicitly define a utility function that treats the probability of a trader becoming a market maker as a pure strategy. We then employ empirical game-theoretic analysis to analyse the market at equilibrium; we illustrate the strategic responses to different setups of the matching mechanisms, how agents are incentivised to become market makers, agent behaviour and market states. Our analysis shows that this spread-based priority works well to reduce market volatility and maintain trading volume, provided that an appropriate setting is used, which weighs spread ranking and price ranking .