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TL;DR

A trading strategy that provides liquidity by continuously quoting bid and ask prices. Market makers profit from the bid-ask spread while managing inventory risk and adverse selection.

By Valenke Exam Prep Team·Last updated 2026-06-03

Market Making

A trading strategy that provides liquidity by continuously quoting bid and ask prices. Market makers profit from the bid-ask spread while managing inventory risk and adverse selection.

Why it matters for interviews

Market making is a core business at many quant firms. Understanding the Avellaneda-Stoikov model, optimal quote placement, and inventory management is essential for trading-focused quant roles.

Definition and Mathematical Foundation

A trading strategy that provides liquidity by continuously quoting bid and ask prices. Market makers profit from the bid-ask spread while managing inventory risk and adverse selection.

Application in Quantitative Finance

Market making is a core business at many quant firms. Understanding the Avellaneda-Stoikov model, optimal quote placement, and inventory management is essential for trading-focused quant roles.

Related Terms

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Frequently Asked Questions

What is the Avellaneda-Stoikov market-making model?▼
A stochastic control model that derives optimal bid/ask quotes as a function of inventory, time, and risk aversion. The optimal spread widens with inventory to manage risk, and tightens as competition increases.
What is adverse selection risk for a market maker?▼
The risk of trading with informed counterparties who know the asset's true value. Market makers lose on average to informed traders and profit from uninformed flow. The spread must cover this expected loss.
How does a market maker manage inventory?▼
By skewing quotes: widening on the side where inventory is excessive. Mean-reversion strategies, hedging with correlated instruments, and position limits are also used to control inventory risk.