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Rock around the Clock: An Agent-Based Model of Low-and High-Frequency Trading

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  • Sandrine Jacob Leal
  • Mauro Napoletano
  • Andrea Roventini
  • Giorgio Fagiolo

Abstract

We build an agent-based model to study how the interplay between low- and high- frequency trading aff ects asset price dynamics. Our main goal is to investigate whether high-frequency trading exacerbates market volatility and generates ash crashes. In the model, low-frequency agents adopt trading rules based on chrono- logical time and can switch between fundamentalist and chartist strategies. On the contrary, high-frequency traders activation is event-driven and depends on price fluctuations. High-frequency traders use directional strategies to exploit market in- formation produced by low-frequency traders. Monte-Carlo simulations reveal that the model replicates the main stylized facts of fi nancial markets. Furthermore, we fi nd that the presence of high-frequency trading increases market volatility and plays a fundamental role in the generation of flash crashes. The emergence of flash crashes is explained by two salient characteristics of high-frequency traders, i.e., their ability to i) generate high bid-ask spreads and ii) synchronize on the sell side of the limit order book. Finally, we fi nd that higher rates of order cancellation by high-frequency traders increase the incidence of flash crashes but reduce their duration.

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Bibliographic Info

Paper provided by Institute for New Economic Thinking (INET) in its series INET Research Notes with number 37.

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Date of creation: 31 Jan 2014
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Handle: RePEc:thk:rnotes:37

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