Crowdedness, Mispricing, Crashes, and Spikes

Boulis Maher Ibrahim and Iordanis Angelos Kalaitzoglou
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Boulis Maher Ibrahim: HWU - Heriot-Watt University [Edinburgh]
Iordanis Angelos Kalaitzoglou: Audencia Business School

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Abstract: This study proposes "reflexive crowdedness" as a mechanism through which order flow can become toxic at ultra-high frequencies (UHFs). Crowdedness, a coordination problem arising from the inability of traders to accurately gauge competition, leads to significant unbalanced mispricing in the form of liquidity costs. This mispricing is amplified by (reflexive) feedforward loops between liquidity and price components and can accumulate rapidly when high-speed traders engage. We develop an empirical framework to examine this mechanism in UHF trading. Results on trades of Dow 30 stocks show that reflexive crowdedness triggers speculative algorithmic trading and drives order flow toxicity and market instability at high frequencies. We formulate a UHF measure of reflexive crowdedness and find it predicts various UHF phenomena, including flash crashes and spikes, more reliably than price volatility and the Volume Synchronised Probability of Informed Trading (VPIN). This makes it highly relevant to investors, market operators, and regulators.

Keywords: High frequency trading (HFT); Overreaction; Arbitrage capacity; Microstructure; Crowdedness; Mispricing; Crashes (search for similar items in EconPapers)
Date: 2025-08
New Economics Papers: this item is included in nep-mst
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Published in Journal of banking & finance = Journal of banking and finance, 2025, 177, pp.177-485. ⟨10.1016/j.jbankfin.2025.107485⟩

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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-05141161

DOI: 10.1016/j.jbankfin.2025.107485

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