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Market microstructure design and flash crashes: A simulation approach

Paul Brewer, Jaksa Cvitanic () and Charles Plott ()
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Paul Brewer: Economic and Financial Technology Consulting

Journal of Applied Economics, 2013, vol. 16, 223-250

Abstract: We study consequences of regulatory interventions in limit order markets that aim at stabilizing the market after an occurrence of a “flash crash”. We use a simulation platform that creates random arrivals of trade orders, that allows us to analyze subtle theoretical features of liquidity and price variability under various market structures. The simulations are performed under continuous double-auction microstructure, and under alternatives, including imposing minimum resting times, shutting off trading for a period of time, and switching to call auction mechanisms. We find that the latter is the most effective in restoring the liquidity of the book and recovery of the price level. However, one has to be cautious about possible consequences of the intervention on the traders’ strategies, including an undesirable slowdown of a convergence to a new equilibrium after a change in fundamentals.

Keywords: market microstructure; flash crash; high frequency trading; call markets; market regulation; market simulation (search for similar items in EconPapers)
JEL-codes: G17 G18 (search for similar items in EconPapers)
Date: 2013
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