Understanding flash crash contagion and systemic risk: A micro–macro agent-based approach

James Paulin, Anisoara Calinescu and Michael Wooldridge

Journal of Economic Dynamics and Control, 2019, vol. 100, issue C, 200-229

Abstract: The purpose of this paper is to advance the understanding of the conditions that give rise to flash crash contagion, particularly with respect to overlapping asset portfolio crowding. To this end, we designed, implemented, and assessed a hybrid micro–macro agent-based model, where price impact arises endogenously through the limit order placement activity of algorithmic traders. Our novel hybrid microscopic and macroscopic model allows us to characterise systemic risk not just in terms of system stability, but also in terms of the speed of financial distress propagation over intraday timescales. We find that systemic risk is strongly dependent on the behaviour of algorithmic traders, on leverage management practices, and on network topology. Our results demonstrate that, for high-crowding regimes, contagion speed is a non-monotone function of portfolio diversification. We also find the surprising result that, in certain circumstances, increased portfolio crowding is beneficial to systemic stability. We are not aware of previous studies that have exhibited this phenomenon, and our results establish the importance of considering non-uniform asset allocations in future studies. Finally, we characterise the time window available for regulatory interventions during the propagation of flash crash distress, with results suggesting ex ante precautions may have higher efficacy than ex post reactions.

Keywords: Agent-based model; Systemic risk; Flash crashes; Limit order book; Algorithmic trading; Portfolio crowding (search for similar items in EconPapers)
JEL-codes: C58 C63 G01 (search for similar items in EconPapers)
Date: 2019
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (14)

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S0165188919300041
Full text for ScienceDirect subscribers only

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:100:y:2019:i:c:p:200-229

DOI: 10.1016/j.jedc.2018.12.008

Access Statistics for this article

Journal of Economic Dynamics and Control is currently edited by J. Bullard, C. Chiarella, H. Dawid, C. H. Hommes, P. Klein and C. Otrok

More articles in Journal of Economic Dynamics and Control from Elsevier
Bibliographic data for series maintained by Catherine Liu ().