Abstract

In this paper, the profitability of simple mechanic market-making strategies with fixed
quoting spreads are tested. It is found that the profitability is obviously related to the volatility
range and trading volume of the contracts. Therefore, it is suggested that, when designing their
market-making strategies, market makers should take such two factors into account. What’s more,
a market maker paradox is also revealed during the test. Solution to this paradox is also put
forward.

Keywords
Market maker, Bid-ask spread, Trading strategy, Paradox

1994 2004

64
 = =

1
2 t

3 t

10
10 10 200 20 20
20 400 20
3

1 1 1 =5
2 5 2
6 5 1
2

4 3
0

Foxpro 6.0
SAS 9.1

1994 2004

1 1 1994 2004 1
1994 Cu9501 1995 Cu9601

65
 3
1994 2004

1 4 1994 2004

1 1994 2004 3

131,377 440,121 15,404 776

338,911 705,322 8,730 1,929
2,596,630 3,619,082 47,800 13,666
22 8,700 946 2

2 1 20

200

150

100

50

0
10 20 30 40 50 60 70 80 90 100 110 120 130 140 150 160 170 180 190 200

-50

1 20 16
10 20 40 50
10

66
1994 2004 166.02
1 1 31450 / 7%
1 31450 5 7% 11007.5
166.02

67
 2 1

10 20 30 40 50 60 70 80 90 100 110 120 130 140 150 160 170 180 190 200

1994 -43.16 -36.37 -30.75 -28.67 -26.18 -23.80 -22.23 -20.91 -20.11 -18.50 -18.88 -17.93 -17.03 -16.45 -15.67 -15.24 -14.46 -14.56 -14.05 -14.10
1995 90.17 101.63 75.90 95.09 68.21 37.86 23.94 25.17 25.95 26.76 26.04 11.50 11.68 12.13 12.36 12.35 12.66 13.22 13.47 13.82
1996 -25.04 -15.51 -9.38 -7.13 -5.15 -5.53 -4.34 -3.54 -2.68 -2.17 -2.51 -2.49 -2.10 -1.58 -1.57 -1.53 -1.51 -1.09 -0.88 -0.64
1997 -17.07 -11.57 -7.98 -6.64 -4.85 -3.68 -3.24 -2.36 -1.85 -1.64 -1.35 -1.23 -0.70 -0.59 -0.61 -0.57 -0.39 -0.38 -0.29 -0.19
1998 -4.13 -3.54 -2.58 -1.78 -1.79 -1.62 -1.48 -1.08 -1.09 -0.81 -0.71 -0.63 -0.85 -0.74 -0.63 -0.51 -0.37 -0.31 -0.26 -0.27
1999 0.27 -5.15 -4.35 -3.03 -2.69 -1.98 -1.41 -1.13 -1.06 -0.60 -0.38 -0.41 -0.47 -0.63 -0.60 -0.46 -0.37 -0.27 -0.32 -0.24
2000 -0.45 -1.90 -1.27 -1.21 -0.88 -0.64 -0.29 -0.43 -0.53 -0.36 -0.40 -0.32 -0.29 -0.23 -0.17 -0.20 -0.17 -0.14 -0.11 -0.08
2001 5.85 -2.70 -1.93 -1.23 -0.64 -0.58 -0.27 -0.20 -0.18 -0.08 0.00 0.02 0.05 0.09 0.10 0.14 0.20 0.16 0.18 0.11
2002 3.19 -3.49 -2.62 -2.24 -1.39 -1.00 -0.82 -0.52 -0.30 -0.18 -0.18 -0.31 -0.19 -0.05 0.03 0.02 -0.03 0.02 0.08 0.14
2003 -14.34 -20.86 -13.58 -12.25 -8.36 -5.83 -4.98 -4.13 -4.32 -4.28 -4.26 -3.45 -2.79 -2.14 -1.56 -1.41 -1.45 -1.39 -1.06 -0.93
2004 170.71 1.56 -12.10 -12.38 -11.68 -11.78 -10.71 -10.20 -9.18 -7.22 -8.88 -7.54 -6.27 -6.62 -5.78 -5.38 -3.94 -3.19 -2.83 -3.10

166.02 2.13 -10.63 18.55 4.62 -18.57 -25.79 -19.32 -15.32 -9.06 -11.50 -22.76 -18.96 -16.79 -14.08 -12.79 -9.82 -7.92 -6.07 -5.48

15.09 0.19 -0.97 1.69 0.42 -1.69 -2.34 -1.76 -1.39 -0.82 -1.05 -2.07 -1.72 -1.53 -1.28 -1.16 -0.89 -0.72 -0.55 -0.50
61.49 35.39 26.86 32.02 23.67 14.81 10.86 10.86 10.83 10.63 10.62 6.95 6.68 6.66 6.48 6.35 6.17 6.28 6.21 6.31
170.71 101.63 75.90 95.09 68.21 37.86 23.94 25.17 25.95 26.76 26.04 11.50 11.68 12.13 12.36 12.35 12.66 13.22 13.47 13.82
-43.16 -36.37 -30.75 -28.67 -26.18 -23.80 -22.23 -20.91 -20.11 -18.50 -18.88 -17.93 -17.03 -16.45 -15.67 -15.24 -14.46 -14.56 -14.05 -14.10

Range* 213.86 137.99 106.64 123.75 94.38 61.66 46.17 46.08 46.06 45.26 44.92 29.42 28.71 28.58 28.03 27.58 27.11 27.78 27.52 27.92

195823 38064 17199 10522 7469 4957 3909 3222 2682 2263 1674 1493 1313 1159 1035 891 825 758 701 643

* Range =

68
 2 3
1994 2004
2

2 10 195823
200 643

PLt
Volt =
Ranget PLt Volt Ranget
PLit = α i + βi1 ⋅ Rangeit + β i 2 ⋅ Volit + ε it
i i=10 20 200
3
ADF 20 3
3 3 10 100

3 ADF
i=10 i=100
Type
Tau Pr<Tau F Pr>F Tau Pr<Tau F Pr>F
Zero Mean -25.33 <.0001 -19.86 <.0001
PLit Single Mean -25.37 <.0001 321.76 0.001 -19.85 <.0001 197 0.001
Trend -25.45 <.0001 323.85 0.001 -19.84 <.0001 196.9 0.001
Zero Mean -4.92 <.0001 -3.53 0.0004
Volit Single Mean -5.31 <.0001 14.11 0.001 -3.86 0.0026 7.45 0.001
Trend -5.7 <.0001 16.26 0.001 -4.22 0.0044 8.91 0.001
Zero Mean -23.42 <.0001 -17.12 <.0001
Rangeit Single Mean -26.19 <.0001 343.03 0.001 -19.84 <.0001 196.82 0.001
Trend -26.19 <.0001 342.93 0.001 -19.84 <.0001 196.8 0.001

4 4
1 PLit Rangeit 20 Rangeit
Rangeit

69
 4
t P-Value t P-Value
Intercept -516.906 -0.567 0.571 Intercept 1401.848 2.832* 0.005

Rangeit -5.902 -4.511* 0.000 Rangeit -5.164 -10.675* 0.000

Volit 0.369 8.597* 0.000 Volit 0.004 0.253 0.801

Intercept 789.407 0.858 0.391 Intercept 1208.581 4.444* 0.000

Rangeit -5.836 -4.444* 0.000 Rangeit -5.075 -19.893* 0.000

Volit 0.044 1.016 0.310 Volit 0.009 0.998 0.319

Intercept 924.534 1.300 0.194 Intercept 1309.533 4.451* 0.000

Rangeit -5.596 -5.598* 0.000 Rangeit -5.060 -19.064* 0.000

Volit 0.011 0.336 0.737 Volit 0.009 0.989 0.323

Intercept 1222.820 1.399 0.162 Intercept 1413.879 4.488* 0.000

Rangeit -5.582 -4.666* 0.000 Rangeit -5.054 -18.399* 0.000

Volit 0.005 0.129 0.897 Volit 0.007 0.733 0.464

Intercept 1127.808 1.673 0.095 Intercept 1504.403 4.440* 0.000

Rangeit -5.440 -6.115* 0.000 Rangeit -5.044 -17.716* 0.000

Volit 0.008 0.281 0.779 Volit 0.008 0.749 0.454

Intercept 989.601 2.177** 0.030 Intercept 1594.098 4.293* 0.000

Rangeit -5.292 -9.335* 0.000 Rangeit -5.033 -16.926* 0.000

Volit 0.007 0.389 0.698 Volit 0.007 0.700 0.484

Intercept 929.688 2.768* 0.006 Intercept 1690.353 4.332* 0.000

Rangeit -5.216 -13.052* 0.000 Rangeit -5.025 -16.492* 0.000

Volit 0.011 0.794 0.427 Volit 0.007 0.687 0.493

Intercept 1059.526 2.935* 0.003 Intercept 1780.829 4.296* 0.000

Rangeit -5.207 -12.600* 0.000 Rangeit -5.022 -16.000* 0.000

Volit 0.008 0.607 0.544 Volit 0.007 0.664 0.507

Intercept 1157.457 2.899* 0.004 Intercept 1888.005 4.253* 0.000

Rangeit -5.202 -11.977* 0.000 Rangeit -5.015 -15.429* 0.000

Volit 0.009 0.622 0.534 Volit 0.007 0.610 0.542

Intercept 1285.955 2.980* 0.003 Intercept 1960.938 4.171* 0.000

Rangeit -5.153 -11.408* 0.000 Rangeit -5.014 -15.018* 0.000

Volit 0.008 0.540 0.590 Volit 0.007 0.553 0.580

* 1% ** 5%

2 PLit Volit 10 Volit

19 Volit PLit Volit

PLit Rangeit PLit Volit

70
 3

PLit Volit
5
3 5

10 20 30 40 50 60 70 80 90 100 110 120 130 140 150 160 170 180 190 200

3 1994 2004 3

3 3

PLij = α 0 + α 1 ⋅ Dmid ,ij + α 2 ⋅ Dmin ij

+ β 0 ⋅ Ln( spread ij ) + β1 ⋅ Dmid ,ij ⋅ Ln( spread ij ) + β 2 ⋅ Dmin ij ⋅ Ln( spread ij ) + ε ij

i i=
j j=1 2 20
PL
Dmid 1
0
Dmin 1
0
Ln(spread)

PLij = 672.13 − 907.59 ⋅ Dmid ,ij − 745.92 ⋅ Dmin,ij

(6.410) (-6.120) (-5.030)
− 141.45 ⋅ Ln( spreadlij ) + 184.95 ⋅ Dmid ,ij ⋅ Ln( spread ij ) + 153.33 ⋅ Dmin,ij ⋅ Ln( spread ij )
(-6.057) (5.600) (4.642)
2
F=10.672 Adjusted R 0.450
t 1%

71
 5 1994 2004 3

10 20 30 40 50 60 70 80 90 100 110 120 130 140 150 160 170 180 190 200

812.66 37.14 19.14 15.37 8.44 -2.49 -2.22 -4.80 4.02 11.59 -6.20 -1.64 4.44 6.67 11.30 12.09 0.39 2.31 4.46 6.16

73.88 3.38 1.74 1.40 0.77 -0.23 -0.20 -0.44 0.37 1.05 -0.56 -0.15 0.40 0.61 1.03 1.10 0.04 0.21 0.41 0.56

190.11 41.92 40.53 33.99 26.24 20.98 17.23 13.05 13.21 13.47 8.70 8.76 8.70 8.95 9.08 8.84 4.42 4.57 4.54 4.59

620.53 106.51 120.31 101.78 78.35 61.40 50.26 37.53 39.22 40.90 24.20 25.20 25.95 26.83 27.87 27.32 12.69 13.46 13.74 14.13

-58.13 -39.57 -29.32 -22.93 -17.26 -13.83 -12.54 -10.04 -8.65 -8.28 -8.56 -7.56 -5.82 -6.31 -5.40 -4.23 -3.63 -3.51 -2.77 -2.68

670398 106758 44647 25766 17352 11272 8577 6765 5453 4493 3408 2859 2466 2147 1907 1622 1465 1301 1164 1035

-153.78 -117.00 -80.52 -67.07 -44.66 -45.17 -48.61 -37.71 -30.17 -22.50 -36.15 -31.60 -28.89 -24.17 -20.59 -20.15 -17.30 -14.79 -12.82 -12.05

-13.98 -10.64 -7.32 -6.10 -4.06 -4.11 -4.42 -3.43 -2.74 -2.05 -3.29 -2.87 -2.63 -2.20 -1.87 -1.83 -1.57 -1.34 -1.17 -1.10

42.15 28.46 22.79 18.21 17.32 12.68 8.73 7.74 7.27 6.68 4.35 3.96 3.64 3.19 2.85 2.82 2.33 2.06 1.94 2.01

94.56 57.18 47.15 35.63 37.65 23.50 8.57 9.51 10.26 11.03 -0.22 -0.05 -0.01 0.18 0.23 0.34 0.24 0.12 0.20 0.27

-85.47 -66.69 -52.41 -44.12 -38.45 -32.27 -27.81 -23.50 -21.19 -18.28 -15.66 -14.14 -13.05 -11.36 -10.16 -10.01 -8.32 -7.36 -6.83 -7.00

37836 18024 11119 8039 6298 4420 3645 3105 2649 2292 1728 1574 1387 1263 1134 944 876 813 751 682

-46.61 -39.29 -34.01 -29.96 -26.64 -24.96 -22.82 -20.97 -19.77 -18.40 -17.96 -16.89 -15.82 -14.86 -14.23 -13.96 -13.41 -12.77 -12.27 -11.59

-4.24 -3.57 -3.09 -2.72 -2.42 -2.27 -2.07 -1.91 -1.80 -1.67 -1.63 -1.54 -1.44 -1.35 -1.29 -1.27 -1.22 -1.16 -1.23 -1.16

1.68 1.59 1.51 1.50 1.47 1.44 1.43 1.41 1.39 1.38 1.32 1.29 1.28 1.26 1.22 1.16 1.15 1.13 1.09 1.06

-1.49 -0.60 -0.42 -0.15 -0.05 -0.14 -0.09 -0.04 -0.03 -0.06 -0.04 -0.03 -0.03 -0.02 -0.02 -0.01 -0.01 0.00 -0.05 -0.01

-6.68 -6.27 -6.01 -5.64 -5.38 -5.13 -4.97 -4.80 -4.71 -4.58 -4.41 -4.27 -4.13 -4.00 -3.88 -3.75 -3.71 -3.63 -3.52 -3.42

1920 1297 1001 821 731 513 471 425 363 336 231 224 215 205 191 165 156 147 138 131

72
 ⎧672.13 − 141.47 ⋅ Ln( spread ij ) for i =
⎪
PLij = ⎨− 235.46 + 43.48 ⋅ Ln( spread ij ) for i =
⎪
⎩− 73.79 + 11.86 ⋅ Ln( spread ij ) for i =

32

32

1 10
1 5
20

73
1

74