1986/12/01 by Maureen O'Hara, Maureen O’Hara, George S. Oldfield · 4 citations
Economics, Econometrics and Finance · Business, Management and Accounting · #Financial Markets and Investment Strategies #Financial Reporting and Valuation Research #Corporate Finance and Governance
paper · doi:10.2307/2330686
This paper examines the influence of risk aversion on the pricing policies of a market maker for securities. It is shown that a market maker's bid-ask spread can be decomposed into a portion for the known limit orders, a risk-neutral adjustment for expected market orders, and a risk adjustment for market order and inventory value uncertainty. It is demonstrated that a risk-averse market maker may set a smaller spread than a risk-neutral specialist. Finally, this paper demonstrates the pervasive role of inventory in affecting both the placement and size of the spread.