IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Log in (now much improved!) to save this paper

Market stability vs. Market resilience : Regulatory policies experiments in an agent based model with low-and high -frequency trading

Listed author(s):
  • Sandrine Jacob Leal

    (CEREFIGE-ICN Business School (Nancy Metz) France)

  • Mauro Napoletano

    (OFCE Sciences Po & SKEMA Business School)

We investigate the effects of different regulatory policies directed towards high-frequency trading (HFT) through an agent-based model of a limit order book able to generate flash crashes as the result of the interactions between low- and high-frequency (HF) traders. We analyze the impact of the imposition of minimum resting times, of circuit breakers (both ex-post and ex-ante types), of cancellation fees and of transaction taxes on asset price volatility and on the occurrence and duration of ash crashes. In the model, low- frequency agents adopt trading rules based on chronological time and can switch between fundamentalist and chartist strategies. In contrast, high-frequency traders activation is event-driven and depends on price fluctuations. In addition, high-frequency traders employ low-latency directional strategies that exploit market information and they can cancel their orders depending on expected profits. Monte-Carlo simulations reveal that reducing HF order cancellation, via minimum resting times or cancellation fees, or discouraging HFT via financial transaction taxes, reduces market volatility and the frequency of ash crashes. However, these policies also imply a longer duration of flash crashes. Furthermore, the introduction of an ex-ante circuit breaker markedly reduces price volatility and removes ash crashes. In contrast, ex-post circuit breakers do not affect market volatility and they increase the duration of flash crashes. Our results show that HFT-targeted policies face a trade-o between market stability and resilience. Policies that reduce volatility and the incidence of flash crashes also imply a reduced ability of the market to quickly recover from a crash. The dual role of HFT, as both a cause of the flash crash and a fundamental actor in the post-crash recovery underlies the above trade-off .

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://www.ofce.sciences-po.fr/pdf/dtravail/WP2016-12.pdf
Download Restriction: no

Paper provided by Observatoire Francais des Conjonctures Economiques (OFCE) in its series Documents de Travail de l'OFCE with number 2016-12.

as
in new window

Length:
Date of creation: Apr 2016
Handle: RePEc:fce:doctra:16012
Contact details of provider: Postal:
69, quai d'Orsay - 75007 PARIS

Phone: 01 44 18 54 00
Fax: 01 45 56 06 15
Web page: http://www.ofce.sciences-po.fr/
Email:


More information through EDIRC

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as
in new window


  1. Brock, William A. & Hommes, Cars H., 1998. "Heterogeneous beliefs and routes to chaos in a simple asset pricing model," Journal of Economic Dynamics and Control, Elsevier, vol. 22(8-9), pages 1235-1274, August.
  2. Harald Hau, 2006. "The Role of Transaction Costs for Financial Volatility: Evidence from the Paris Bourse," Journal of the European Economic Association, MIT Press, vol. 4(4), pages 862-890, 06.
  3. Frank Westerhoff, 2003. "Heterogeneous traders and the Tobin tax," Journal of Evolutionary Economics, Springer, vol. 13(1), pages 53-70, 02.
  4. Thierry Foucault & Ailsa Röell & Patrik Sandås, 2003. "Market Making with Costly Monitoring: An Analysis of the SOES Controversy," Review of Financial Studies, Society for Financial Studies, vol. 16(2), pages 345-384.
  5. Neil Johnson & Guannan Zhao & Eric Hunsader & Jing Meng & Amith Ravindar & Spencer Carran & Brian Tivnan, 2012. "Financial black swans driven by ultrafast machine ecology," Papers 1202.1448, arXiv.org.
  6. Breckenfelder, Johannes, 2013. "Competition between high-frequency traders, and market quality," MPRA Paper 66715, University Library of Munich, Germany, revised Dec 2013.
  7. Pellizzari, Paolo & Westerhoff, Frank, 2009. "Some effects of transaction taxes under different microstructures," Journal of Economic Behavior & Organization, Elsevier, vol. 72(3), pages 850-863, December.
  8. Friederich, Sylvain & Payne, Richard, 2015. "Order-to-trade ratios and market liquidity," Journal of Banking & Finance, Elsevier, vol. 50(C), pages 214-223.
  9. G. Fagiolo & C. Birchenhall & P. Windrum, 2007. "Empirical Validation in Agent-based Models: Introduction to the Special Issue," Computational Economics, Springer;Society for Computational Economics, vol. 30(3), pages 189-194, October.
  10. Sandrine Jacob Leal & Mauro Napoletano & Andrea Roventini & Giorgio Fagiolo, 2016. "Rock around the clock: An agent-based model of low- and high-frequency trading," Journal of Evolutionary Economics, Springer, vol. 26(1), pages 49-76, March.
  11. Andrei A. Kirilenko & Andrew W. Lo, 2013. "Moore's Law versus Murphy's Law: Algorithmic Trading and Its Discontents," Journal of Economic Perspectives, American Economic Association, vol. 27(2), pages 51-72, Spring.
  12. George Diacogiannis & Nikolaos Patsalis & Nickolaos Tsangarakis & Emanuel Tsiritakis, 2005. "Price limits and overreaction in the Athens stock exchange," Applied Financial Economics, Taylor & Francis Journals, vol. 15(1), pages 53-61.
  13. J. Doyne Farmer, 2002. "Market force, ecology and evolution," Industrial and Corporate Change, Oxford University Press, vol. 11(5), pages 895-953, November.
  14. Avanidhar Subrahmanyam, 2013. "Algorithmic trading, the Flash Crash, and coordinated circuit breakers," Borsa Istanbul Review, Research and Business Development Department, Borsa Istanbul, vol. 13(3), pages 4-9, September.
  15. Greenwald, Bruce C & Stein, Jeremy C, 1991. "Transactional Risk, Market Crashes, and the Role of Circuit Breakers," The Journal of Business, University of Chicago Press, vol. 64(4), pages 443-462, October.
  16. Pagan, Adrian, 1996. "The econometrics of financial markets," Journal of Empirical Finance, Elsevier, vol. 3(1), pages 15-102, May.
  17. Paul Windrum & Giorgio Fagiolo & Alessio Moneta, 2007. "Empirical Validation of Agent-Based Models: Alternatives and Prospects," Journal of Artificial Societies and Social Simulation, Journal of Artificial Societies and Social Simulation, vol. 10(2), pages 1-8.
  18. Anton Golub & John Keane & Ser-Huang Poon, 2012. "High Frequency Trading and Mini Flash Crashes," Papers 1211.6667, arXiv.org.
  19. James Tobin, 1978. "A Proposal for International Monetary Reform," Eastern Economic Journal, Eastern Economic Association, vol. 4(3-4), pages 153-159, Jul/Oct.
  20. Westerhoff, Frank H. & Dieci, Roberto, 2006. "The effectiveness of Keynes-Tobin transaction taxes when heterogeneous agents can trade in different markets: A behavioral finance approach," Journal of Economic Dynamics and Control, Elsevier, vol. 30(2), pages 293-322, February.
  21. J. Doyne Farmer & Spyros Skouras, 2013. "An ecological perspective on the future of computer trading," Quantitative Finance, Taylor & Francis Journals, vol. 13(3), pages 325-346, February.
  22. James Brugler & Oliver Linton, 2014. "Single stock circuit breakers on the London Stock Exchange: do they improve subsequent market quality?," CeMMAP working papers CWP07/14, Centre for Microdata Methods and Practice, Institute for Fiscal Studies.
  23. Jones, Charles M & Seguin, Paul J, 1997. "Transaction Costs and Price Volatility: Evidence from Commission Deregulation," American Economic Review, American Economic Association, vol. 87(4), pages 728-737, September.
  24. J. Doyne Farmer & Paolo Patelli & Ilija I. Zovko, 2003. "The Predictive Power of Zero Intelligence in Financial Markets," Papers cond-mat/0309233, arXiv.org, revised Feb 2004.
  25. Lauterbach, Beni & Ben-Zion, Uri, 1993. " Stock Market Crashes and the Performance of Circuit Breakers: Empirical Evidence," Journal of Finance, American Finance Association, vol. 48(5), pages 1909-1925, December.
  26. Kirman Alan & Teyssière Gilles, 2002. "Microeconomic Models for Long Memory in the Volatility of Financial Time Series," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 5(4), pages 1-23, January.
  27. Demary, Markus, 2010. "Transaction taxes and traders with heterogeneous investment horizons in an agent-based financial market model," Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy (IfW), vol. 4, pages 1-44.
  28. M. Bartolozzi, 2010. "A multi agent model for the limit order book dynamics," The European Physical Journal B: Condensed Matter and Complex Systems, Springer;EDP Sciences, vol. 78(2), pages 265-273, November.
  29. Hasbrouck, Joel & Saar, Gideon, 2013. "Low-latency trading," Journal of Financial Markets, Elsevier, vol. 16(4), pages 646-679.
  30. Daniel Fricke & Thomas Lux, 2015. "The effects of a financial transaction tax in an artificial financial market," Journal of Economic Interaction and Coordination, Springer;Society for Economic Science with Heterogeneous Interacting Agents, vol. 10(1), pages 119-150, April.
  31. Anirban Chakraborti & Ioane Muni Toke & Marco Patriarca & Frederic Abergel, 2011. "Econophysics review: I. Empirical facts," Quantitative Finance, Taylor & Francis Journals, vol. 11(7), pages 991-1012.
  32. R. Cont, 2001. "Empirical properties of asset returns: stylized facts and statistical issues," Quantitative Finance, Taylor & Francis Journals, vol. 1(2), pages 223-236.
  33. Dominique Dupont & Gabriel Lee, 2007. "Effects of Securities Transaction Taxes on Depth and Bid-Ask Spread," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 31(2), pages 393-400, May.
  34. Cho, David D. & Russell, Jeffrey & Tiao, George C. & Tsay, Ruey, 2003. "The magnet effect of price limits: evidence from high-frequency data on Taiwan Stock Exchange," Journal of Empirical Finance, Elsevier, vol. 10(1-2), pages 133-168, February.
  35. Recep Bildik & Güzhan Gülay, 2006. "Are Price Limits Effective? Evidence From The Istanbul Stock Exchange," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 29(3), pages 383-403.
  36. G. J. Santoni & Tung Liu, 1993. "Circuit breakers and stock market volatility," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 13(3), pages 261-277, 05.
  37. Alfarano, Simone & Lux, Thomas & Wagner, Friedrich, 2010. "Excess Volatility and Herding in an Artificial Financial Market: Analytical Approach and Estimation," MPRA Paper 24719, University Library of Munich, Germany.
  38. Karl F Habermeier & Andrei A Kirilenko, 2001. "Securities Transaction Taxes and Financial Markets," IMF Working Papers 01/51, International Monetary Fund.
  39. Hommes, Cars & Huang, Hai & Wang, Duo, 2005. "A robust rational route to randomness in a simple asset pricing model," Journal of Economic Dynamics and Control, Elsevier, vol. 29(6), pages 1043-1072, June.
  40. Ilija Zovko & J Doyne Farmer, 2002. "The power of patience: a behavioural regularity in limit-order placement," Quantitative Finance, Taylor & Francis Journals, vol. 2(5), pages 387-392.
  41. Menkveld, Albert J., 2013. "High frequency trading and the new market makers," Journal of Financial Markets, Elsevier, vol. 16(4), pages 712-740.
  42. Clark, Peter K, 1973. "A Subordinated Stochastic Process Model with Finite Variance for Speculative Prices," Econometrica, Econometric Society, vol. 41(1), pages 135-155, January.
  43. Lavička, H. & Lichard, T. & Novotný, J., 2016. "Sand in the wheels or wheels in the sand? Tobin taxes and market crashes," International Review of Financial Analysis, Elsevier, vol. 47(C), pages 328-342.
  44. Kodres, Laura E & O'Brien, Daniel P, 1994. "The Existence of Pareto-Superior Price Limits," American Economic Review, American Economic Association, vol. 84(4), pages 919-932, September.
  45. Roll, R., 1989. "Price Volatility, International Market Links, And Their Implications For Regulatory Policies," Papers t10, Columbia - Center for Futures Markets.
  46. Fama, Eugene F, 1970. "Efficient Capital Markets: A Review of Theory and Empirical Work," Journal of Finance, American Finance Association, vol. 25(2), pages 383-417, May.
  47. De Long, J Bradford & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, 1990. "Noise Trader Risk in Financial Markets," Journal of Political Economy, University of Chicago Press, vol. 98(4), pages 703-738, August.
  48. Marco Avellaneda & Sasha Stoikov, 2008. "High-frequency trading in a limit order book," Quantitative Finance, Taylor & Francis Journals, vol. 8(3), pages 217-224.
  49. Umlauf, Steven R., 1993. "Transaction taxes and the behavior of the Swedish stock market," Journal of Financial Economics, Elsevier, vol. 33(2), pages 227-240, April.
  50. Copeland, Thomas E & Galai, Dan, 1983. " Information Effects on the Bid-Ask Spread," Journal of Finance, American Finance Association, vol. 38(5), pages 1457-1469, December.
  51. Kim, Kenneth & Rhee, S Ghon, 1997. " Price Limit Performance: Evidence from the Tokyo Stock Exchange," Journal of Finance, American Finance Association, vol. 52(2), pages 885-899, June.
  52. Robert Pollin & Dean Baker & Marc Schaberg, 2003. "Securities Transaction Taxes for U.S. Financial Markets," Eastern Economic Journal, Eastern Economic Association, vol. 29(4), pages 527-558, Fall.
  53. Benoit Mandelbrot, 2015. "The Variation of Certain Speculative Prices," World Scientific Book Chapters,in: THE WORLD SCIENTIFIC HANDBOOK OF FUTURES MARKETS, chapter 3, pages 39-78 World Scientific Publishing Co. Pte. Ltd..
  54. Chiarella, Carl & He, Xue-Zhong, 2003. "Heterogeneous Beliefs, Risk, And Learning In A Simple Asset-Pricing Model With A Market Maker," Macroeconomic Dynamics, Cambridge University Press, vol. 7(04), pages 503-536, September.
  55. Marco Bartolozzi, 2010. "A Multi Agent Model for the Limit Order Book Dynamics," Papers 1005.0182, arXiv.org, revised Oct 2010.
  56. Eric Budish & Peter Cramton & John Shim, 2015. "Editor's Choice The High-Frequency Trading Arms Race: Frequent Batch Auctions as a Market Design Response," The Quarterly Journal of Economics, Oxford University Press, vol. 130(4), pages 1547-1621.
  57. Thierry Ané & Hélyette Geman, 2000. "Order Flow, Transaction Clock, and Normality of Asset Returns," Journal of Finance, American Finance Association, vol. 55(5), pages 2259-2284, October.
  58. Mannaro, Katiuscia & Marchesi, Michele & Setzu, Alessio, 2008. "Using an artificial financial market for assessing the impact of Tobin-like transaction taxes," Journal of Economic Behavior & Organization, Elsevier, vol. 67(2), pages 445-462, August.
  59. Westerhoff Frank H., 2008. "The Use of Agent-Based Financial Market Models to Test the Effectiveness of Regulatory Policies," Journal of Economics and Statistics (Jahrbuecher fuer Nationaloekonomie und Statistik), De Gruyter, vol. 228(2-3), pages 195-227, April.
  60. Gudrun Ehrenstein, 2002. "Cont-Bouchaud percolation model including Tobin tax," Papers cond-mat/0205320, arXiv.org.
  61. Paul Brewer & Jaksa Cvitanic & Charles R. Plott, 2013. "Market microstructure design and flash crashes: A simulation approach," Journal of Applied Economics, Universidad del CEMA, vol. 16, pages 223-250, November.
  62. Sandrine Jacob Leal & Mauro Napoletano & Andrea Roventini & Giorgio Fagiolo, 2016. "Rock around the clock: An agent-based model of low- and high-frequency trading," Journal of Evolutionary Economics, Springer, vol. 26(1), pages 49-76, March.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:fce:doctra:16012. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Francesco Saraceno)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.