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Optimal half-spread
A market maker quotes a bid at fair value minus and an ask at fair value plus , with . In each round the ask is lifted with probability and, independently, the bid is hit with the same probability, each trading one unit at the quoted price. Fair value does not change. What is the largest achievable expected profit per round relative to fair value, in the same units as ?
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Hint
Profit per side is times its fill probability; maximize that quadratic.
Solution
- Expected profit per round is .
- The maximum is where , so .
- The profit there is .
Answer: