Could anyone suggest some literature or have any practical advice for marking a market in thinly traded assets with the following characteristics:
0-10 trades per day.
Open limit-order book with 0-5 resting orders.
Almost no correlation with more liquid assets
Relatively high volatility.
Small number of market participants.
Very wide spreads that will hopefully make the risk worthwhile.
I am most interested in price discovery. How should I best use the limited information available and how should I protect myself against predatory traders who may take advantage of my algorithms by moving the market?
Research where the liquidity is, Who are the holders and who have historically been the buyers. Getting insight who the buyers and at what price level they would sell (or buy more) is a good technique. Often time ownership information is available to the public information. Once you figure out such levels then you know the price levels you can provide larger sized liquidity. Customer limit orders and prints on the tape can help benchmark your inside. You will want to consider displaying smaller size at narrower prices but have the capability to provide larger sized liquidity wider than the inside. Look for short term dislocation of prices can bring profit opportunities. Be careful if you have firm risk obligations and/or regulatory obligations to cover short positions that you can not borrow (such as SEC's reg SHO for equity short positions).
There's a decent amount of literature about market making under uncertainty, one just needs to look. Start with the below and then use this title as a search for other relevant articles, it's cited a lot: