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Rock around the clock: an agent-based model of low- and high-frequency trading

Author

Listed:
  • Sandrine Jacob Leal

    (ICN Business School, CEREFIGE - Centre Européen de Recherche en Economie Financière et Gestion des Entreprises - UL - Université de Lorraine)

  • Mauro Napoletano

    (OFCE - Observatoire français des conjonctures économiques (Sciences Po) - Sciences Po - Sciences Po)

  • Andrea Roventini

    (SSSUP - Scuola Universitaria Superiore Sant'Anna = Sant'Anna School of Advanced Studies [Pisa])

  • Giorgio Fagiolo

    (SSSUP - Scuola Universitaria Superiore Sant'Anna = Sant'Anna School of Advanced Studies [Pisa])

Abstract

We build an agent-based model to study how the interplay between low- and high frequency trading affects asset price dynamics. Our main goal is to investigate whether high-frequency trading exacerbates market volatility and generates flash crashes. In the model, low-frequency agents adopt trading rules based on chronological time and can switch between fundamentalist and chartist strategies. On the contrary, high-frequency traders activation is event-driven and depends on price the contrary, high-frequency traders activation is event-driven and depends on price formation produced by low-frequency traders. Monte-Carlo simulations reveal that the model replicates the main stylized facts of financial markets. Furthermore, we found 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 found that higher rates of order cancellation by high-frequency traders increase the incidence of flash crashes but reduce their duration.

Suggested Citation

  • Sandrine Jacob Leal & Mauro Napoletano & Andrea Roventini & Giorgio Fagiolo, 2014. "Rock around the clock: an agent-based model of low- and high-frequency trading," Working Papers hal-01070542, HAL.
    • Handle: RePEc:hal:wpaper:hal-01070542
    Note: View the original document on HAL open archive server: https://sciencespo.hal.science/hal-01070542v1
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    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G01 - Financial Economics - - General - - - Financial Crises
    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques

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