Rock around the clock: an agent-based model of low- and high-frequency trading

Sandrine Jacob Leal (1, 2) , Mauro Napoletano (3) , Andrea Roventini (4) , Giorgio Fagiolo (4)

1 ICN Business School
2 CEREFIGE - Centre Européen de Recherche en Economie Financière et Gestion des Entreprises
3 OFCE - Observatoire français des conjonctures économiques (Sciences Po)
4 SSSUP - Scuola Universitaria Superiore Sant'Anna [Pisa]

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 the contrary, high-frequency traders activation is event-driven and depends on price formation produced by low-frequency traders. Monte-Carlo simulations reveal that the model replicates the main stylized facts of financial markets. Furthermore, we found 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 found that higher rates of order cancellation by high-frequency traders increase the incidence of flash crashes but reduce their duration.

Mots clés: Agent-based models; Limit order book; High-frequency trading; low-frequency trading; Flash crashes; Market volatility

Domaines: Economies et finances

Sandrine Jacob Leal, Mauro Napoletano, Andrea Roventini, Giorgio Fagiolo. Rock around the clock: an agent-based model of low- and high-frequency trading. 2014. ⟨hal-01070542⟩