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The deeds of speed: an agent-based model of market liquidity and flash episodes

Geir-Are Karvik (), Joseph Noss (), Jack Worlidge () and Daniel Beale ()
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Geir-Are Karvik: Bank of England, Postal: Bank of England, Threadneedle Street, London, EC2R 8AH
Joseph Noss: Bank of England, Postal: Bank of England, Threadneedle Street, London, EC2R 8AH
Jack Worlidge: Bank of England, Postal: Bank of England, Threadneedle Street, London, EC2R 8AH
Daniel Beale: Bank of England, Postal: Bank of England, Threadneedle Street, London, EC2R 8AH

No 743, Bank of England working papers from Bank of England

Abstract: This paper examines the role of high-frequency traders in flash episodes in electronic financial markets. To do so, we construct an agent-based model of a market for a financial asset in which trading occurs through a central limit order book. The model consists of heterogeneous agents with different trading strategies and frequencies, and is calibrated to high-frequency time series data on the sterling-US dollar exchange rate. Flash episodes occur in the model due to the procyclical behaviour of high-frequency market participants. This is aligned with some empirical evidence as to the drivers of real-world flash crashes. We find that the prevalence of flash episodes increases with the frequency with which high-frequency market participants trade compared to their low-frequency counterparts. This provides tentative theoretical evidence that the recent growth in high-frequency trading across some markets has led to flash episodes. Furthermore, we adapt the model so that large movements in price trigger temporary halts in trading (ie circuit breakers). This is found to reduce the magnitude and frequency of flash episodes.

Keywords: Agent-based modelling; high-frequency trading; financial stability; market liquidity; flash episodes; principal trading firms (PTFs) (search for similar items in EconPapers)
JEL-codes: C63 G11 G12 G17 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cmp, nep-hme and nep-mst
Date: 2018-07-27
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Persistent link: https://EconPapers.repec.org/RePEc:boe:boeewp:0743

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