What Is “Inventory Risk” and How Does It Affect RFQ Quoting?

Inventory risk is the risk that the assets a market maker holds (their inventory) will decrease in value before they can be sold or hedged. In RFQ quoting, if a market maker is already long a particular option, they face negative inventory risk if they continue to buy more of that option.

To manage this, they will quote less aggressively (wider spread) on the side that adds to their current inventory and more aggressively on the side that reduces it, effectively using their quotes to rebalance their book.