I have read a few papers on market making and all(nearly) assume that the stock follows a brownian motion with no drift and constant volatility.These assumptions seems un-intuitive to me because of intraday volatility and garch effects.

I also downloaded some free tick by tick data of EURUSD from internet and ran the market making models of avellanda and stoikov on it and the backtest results were quite poor.

Can any practitioner or anyone provide some tips or methods to adjust the volatility for my project ,any reference material would also be appreciated.

  • $\begingroup$ Hi : The authors probably assume that because there are so many things going on in those market making models that assuming constant volatility, makes things somewhat easier. I don't know if it's useful but here's a possibly relevant paper. researchgate.net/publication/…. Other well known people in econophysics are bouchaud, doyne farmer, gueant, rama cont and lehalle. I don't know if they build intraday volatility models but you could check if they have websites to see if there's anything useful. $\endgroup$
    – mark leeds
    Commented Mar 11, 2020 at 21:01
  • $\begingroup$ I tried modelling volatility as a garch process and also used other variants of garch ,still not one success.God its tough to make a profitable strategy(forget about the sharpe). $\endgroup$
    – pppp_prs
    Commented Apr 1, 2020 at 19:54
  • 2
    $\begingroup$ I have never been a marketmaker. But my impression is that, buying at the bid and selling at the ask it is not difficult to make money a decent percentage of the time. And the typical marketmaker in FX or stocks does not use fancy models but common sense and rules of thumb (options is a different story). What am I missing? $\endgroup$
    – nbbo2
    Commented Apr 1, 2020 at 20:22
  • 4
    $\begingroup$ Not a single options trader on the planet thinks that volatility is constant. It goes up and down like any other market variable. How can any paper think it’s constant $\endgroup$
    – dm63
    Commented Apr 2, 2020 at 2:25
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    $\begingroup$ This looks useful a a glance. It's a little old but old school isn't necessarily a bad thing. The more current topic research wise is "realized volatility". bibliotecadigital.fgv.br/dspace/bitstream/handle/10438/424/… $\endgroup$
    – mark leeds
    Commented Apr 2, 2020 at 21:19

1 Answer 1


That's true that in market making papers, like Dealing with the Inventory Risk. A solution to the market making problem 2012 by Guéant, L and Fernandez-Tapia, the volatility is often taken as constant.

What does it means? indeed you have two nature of uncertainties on the table when you make the market:

  • the mark to maket value of your inventory. from a quantitative viewpoint on market making, the volatility is the proxy that your inventories goes against you. The volatility is a way to mesure the expected value of your inventory in the future.
  • the probability that other market participants will trade with you, that leads to two effects: it allows to reduce your inventory (reacting to an anticipation of risk, thanks to your expectation of the volatility), or it could inflate your inventory towards more imbalance in an undesired solution (this is typically measure the adverse selection risk, that very often practitioners call toxicity of the flow).

They are very different in nature. If you know something about future prices, for instance thanks to a calendar (some economic numbers will be disclosed during the trading day, at 14:30 for Europe, but you do not know if they will be positive or not): put this information in your volatility model. It will naturally tell to the optimizer that you have to reduce your inventory before 2.30pm.

If you have a directional information on the price, for instance a News has just been disclosed about a patent issued by a company (think about the announce of Pfizer 's covid vaccine), it is affecting the flow of other participants in the direction of the information: if your quotes do not adjust, they will be hit a bad way. They you have to put this in your model of the probability of being lifted (that is often an point process with asymmetric intensities on the bid and ask side).


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