Adverse Selection Market Making Interview
Adverse selection market making interview guide for understanding informed counterparties, expected loss, spread, and quote updates.
Candidates asked why a trade against their quote might contain information.
Adverse selection is trading against better information
Adverse selection happens when counterparties are more likely to trade with you when your quote is favorable to them because they know or infer something you missed.
It creates expected loss
If informed traders buy only when your ask is too cheap or sell only when your bid is too high, your filled trades can have negative selection.
Concrete example
If you quote an event at 50 and informed traders buy only when the true probability is closer to 60, your ask may be picked off even though it looked fair before the trade.
Spread compensates for selection risk
A wider spread can help compensate for the possibility that fills are more likely when your quote is wrong.
Update after suspicious flow
If flow suggests informed trading, update fair value or widen the spread. Explain the evidence instead of assuming every trade is informative.
Common mistakes
Candidates often ignore why the counterparty chose to trade. In market making, the decision to hit your quote is itself information to consider.
Practice the pattern
Use the LeetQuidity curriculum and calibration to turn this topic into a focused practice plan.