Regulatory changes associated with the market helps in bringing trends in the trading sector. Any change occurring with this review can really affect both the supply and demand for market-making services and are often referred to as the drivers of adjustment in the market making framework.
Market-driven adjustments offered to MM services
It is a known fact that the market-making involves risk. Since the last years, many dedicated market participants from the most advanced economies and also from the several emerging markets have helped in decreasing the stress linked with these risks.
- One way to achieve this is by selecting the typical financial instrument. When considered from the view of market liquidity, when a generous amount of supply-demand imbalance is sensed, the market-makers willingly come forward to take and mitigate the respective inventory risk and thereby helps in creating a marked decline in the dealers’ risk tolerance level that would adversely affect the economic market resilience.
- As a result of financial crisis, many nations suffered a decline in the VaR aggregate which then became a trend among the major banks established with the advanced economies and is often bonded to widen the deleveraging efforts.
The main market driving factors include
- Reassessing of risk-return trade-off: After experiencing the financial crunch, almost all the market makers have started reassessing the trading returns as if they are high and robust enough to justify the risk taken. The risk incentives from the return of similar activities have been revised and further has led to the reconsideration of allocating both capital and the funding cost to increase the rate of taking market risk.
- A responsive way of risk measurement: Some of the risk measuring factors like VaR always tend to rise with the increase in volatility keeping risks close to the given trading constraints or VaR value. Special consideration should be given to the dealers’ feedback that signals the volatility changes and this help us to be ready with the decent risk measures. Both of these factors have a direct relationship and the MMs are forced to reduce their recent exposures aggressively than in the past.
- Alternatives for redistributing risks: MMs are always ready with alternative ways for hedging or netting out their positions especially in the liquid markets. But with the rise of the financial crisis, all these derivatives and strategies have deteriorated and has proven to be less effective in nature. This, in fact, has reduced the risk tolerating level of MMs as they step in great positions that are truly difficult to hedge.