The Impact of Designated Market Makers on Market Liquidity and Competition: A Simulation Approach

Abstract: This paper conducts an empirical investigation into the effects of Designated Market Makers (DMMs) on key market quality indicators, such as liquidity, bid-ask spreads, and order fulfillment ratios. Through agent-based simulations, this study explores the impact of varying competition levels and incentive structures among DMMs on market dynamics. It aims to demonstrate that DMMs are crucial for enhancing market liquidity and stabilizing price spreads, thereby affirming their essential role in promoting market efficiency. Our findings confirm the impact of the number of Designated Market Makers (DMMs) and asset diversity on market liquidity. The result also suggests that an optimal level of competition among DMMs can maximize liquidity benefits while minimizing negative impacts on price discovery. Additionally, the research indicates that the benefits of increased number of DMMs diminish beyond a certain threshold, implying that excessive incentives may not further improve market quality metrics.