Why a market maker skews quotes when holding inventory

Question

A market maker normally quotes symmetrically around fair value, say $99.99$ bid and $100.01$ ask. After absorbing a wave of customer sells, it is now long $50{,}000$ shares, well beyond its comfortable limit. It responds by moving both quotes down, to roughly $99.95$ bid and $99.98$ ask.

Explain the mechanics. Why skew the quotes down rather than simply widen them?

Accepted Answer

Widening symmetrically reduces the rate of trading on both sides equally, but it does nothing to fix the real problem: the maker is carrying directional risk it does not want. Skewing solves that directly. Lower the ask to attract buyers. By posting a cheaper offer than competitors, the maker makes it attractive for other participants to buy from it, which sells down its long inventory. It is willing to give up a little edge to get flat. Lower the bid to repel more sells. A lower bid makes the maker a worse place to sell into, so it stops accumulating even more length. It effectively steps ba…

Why a market maker skews quotes when holding inventory

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