Market Microstructure and Adverse Selection: Bid-Ask Bounce, Roll's Measure, Glosten-Milgrom, Kyle's Lambda, Order Flow Toxicity (VPIN), and Maker-Taker Economics

Deep End Era. Engineering with Sankalp · Oct 29, 2026 · 1h 19m

If a market maker buys at the Bid and sells one cent higher at the Ask ten thousand times a day, why can they still go bankrupt by four in the afternoon? In Part Two of our Quantitative Finance series, we derive the mathematics of Adverse Selection and Market Microstructure by ear: Roll's 1984 Bid-Ask Bounce formula, Glosten and Milgrom's 1985 Bayesian spread updates, Pete Kyle's 1985 Insider Trading Equilibrium and Kyle's Lambda, Avellaneda-Stoikov inventory reservation prices, Easley-López de Prado-O'Hara's VPIN toxicity metric, and why wholesale internalizers pay retail brokers for order…