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Setting your bid and ask against informed traders

Asked at Citadel Securities, Jane Street

An asset is worth \100today,butitstruevaluetoday, but its true valueVwillturnouttobeeitherwill turn out to be either$102oror$98(eachequallylikely,amoveof(each equally likely, a move ofd = $2).Afraction). A fraction \alpha = 0.20ofthetradersyoufaceareinformed,theyalreadyknowof the traders you face are **informed**, they already knowVandwillbuyifitsand will buy if it's$102,sellifits, sell if it's $98.Theother. The other 80%arenoisetraderswhobuyorsellatrandom( are noise traders who buy or sell at random (50/50$).

Where should you set your bid and ask so that you break even against this flow?

Your answer

This one is open-ended. Work it through, then check your reasoning against the full solution.

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