Quoto

Learn / Library / Market making

Break-even ask

Market makingHard

A contract is worth or with equal probability. Each arriving trader is informed with probability , in which case the trader buys when the value is and sells when it is . Otherwise the trader is uninformed and buys or sells with probability each. The market maker sets the ask so that the expected profit on a buy order is exactly zero. What is the ask?

Checking an answer needs JavaScript. The hint and the solution open without it.

A whole number, a decimal, a fraction like 3/8 or a percent.

Hint

The ask equals the expected value given that the order is a buy.

Solution
  1. A buy arrives with probability when the value is , and with probability when it is .
  2. By Bayes, the probability that the value is given a buy is .
  3. The ask is .

Answer: