How Does a Market maker’S’inventory Risk’ Directly Cause the Bid-Offer Spread to Widen during High Volatility?

Inventory risk is the potential loss from an unfavorable price movement in the assets a market maker holds (their inventory) before they can hedge or liquidate the position. In high volatility, the probability and magnitude of such adverse price changes increase significantly.

To cover this amplified risk of loss, the market maker must demand a larger profit margin on each trade, which they achieve by widening the bid-offer spread.