Abstract

http://ssrn.com/abstract=1695041
 
 

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The Microstructure of the ‘Flash Crash’: Flow Toxicity, Liquidity Crashes and the Probability of Informed Trading


David Easley


Cornell University - Department of Economics

Marcos Lopez de Prado


Guggenheim Partners, LLC; Lawrence Berkeley National Laboratory; RCC at Harvard University

Maureen O'Hara


Cornell University - Samuel Curtis Johnson Graduate School of Management

November 19, 2010

The Journal of Portfolio Management, Vol. 37, No. 2, pp. 118-128, Winter 2011

Abstract:     
The ‘flash crash’ of May 6th 2010 was the second largest point swing (1,010.14 points) and the biggest one-day point decline (998.5 points) in the history of the Dow Jones Industrial Average. For a few minutes, $1 trillion in market value vanished. In this paper, we argue that the ‘flash crash’ is the result of the new dynamics at play in the current market structure. We highlight the role played by order toxicity in affecting liquidity provision, and we show that a measure of this toxicity, the Volume-Synchronized Probability of Informed Trading (VPIN)*, captures the increasing toxicity of the order flow in the hours and days prior to collapse. Since the ‘flash crash’ might have been avoided had liquidity providers remained in the marketplace, a solution is proposed in the form of a ‘VPIN contract’ which would allow them to dynamically monitor and manage their risks.

Number of Pages in PDF File: 15

Keywords: Flash crash, liquidity, flow toxicity, market microstructure, VPIN

JEL Classification: C02, D52, D53, G14

Accepted Paper Series


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Date posted: October 22, 2010 ; Last revised: January 31, 2011

Suggested Citation

Easley, David and Lopez de Prado, Marcos and O'Hara, Maureen, The Microstructure of the ‘Flash Crash’: Flow Toxicity, Liquidity Crashes and the Probability of Informed Trading (November 19, 2010). The Journal of Portfolio Management, Vol. 37, No. 2, pp. 118-128, Winter 2011. Available at SSRN: http://ssrn.com/abstract=1695041

Contact Information

David Easley (Contact Author)
Cornell University - Department of Economics ( email )
414 Uris Hall
Ithaca, NY 14853-7601
United States
607-255-6283 (Phone)
607-255-2818 (Fax)
Marcos Lopez de Prado
Guggenheim Partners, LLC ( email )
330 Madison Avenue
New York, NY 10017
United States
HOME PAGE: http://www.QuantResearch.info
Lawrence Berkeley National Laboratory ( email )
One Cyclotron Road
Berkeley, CA 94720
United States
HOME PAGE: http://www.lbl.gov
RCC at Harvard University ( email )
26 Trowbridge Street
Cambridge, MA 02138
United States
HOME PAGE: http://www.rcc.harvard.edu
Maureen O'Hara
Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )
Ithaca, NY 14853
United States
607-255-3645 (Phone)
607-255-5993 (Fax)
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