Rock around the Clock: An Agent-Based Model of Low- and High-Frequency Trading

Jacob Leal, Sandrine; Napoletano, Mauro; Roventini, Andrea; Fagiolo, Giorgio

Rock around the Clock: An Agent-Based Model of Low- and High-Frequency Trading

Sandrine Jacob Leal, Mauro Napoletano, Andrea Roventini and Giorgio Fagiolo ()
Additional contact information
Sandrine Jacob Leal: CEREFIGE - ICN Business School (Nancy-Metz)

No 2014-21, GREDEG Working Papers from Groupe de REcherche en Droit, Economie, Gestion (GREDEG CNRS), Université Côte d'Azur, France

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 fluctuations. High-frequency traders use directional strategies to exploit market in-formation produced by low-frequency traders. Monte-Carlo simulations reveal that the model replicates the main stylized facts of financial markets. Furthermore, we find 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 find that higher rates of order cancellation by high-frequency traders increase the incidence of flash crashes but reduce their duration.

Keywords: Agent-based models; Limit order book; High-frequency trading; Low-frequency trading; Flash crashes; Market volatility (search for similar items in EconPapers)
JEL-codes: C63 G01 G12 (search for similar items in EconPapers)
Pages: 26 pages
Date: 2014-06
New Economics Papers: this item is included in nep-cmp, nep-mst and nep-ore
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Citations: View citations in EconPapers (17)

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Persistent link: https://EconPapers.repec.org/RePEc:gre:wpaper:2014-21

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