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The Microstructure of the ‘Flash Crash’: Flow Toxicity, Liquidity Crashes and the Probability of Informed TradingDavid EasleyCornell University - Department of Economics Marcos Lopez de PradoHess Energy Trading Company; Lawrence Berkeley National Laboratory; RCC at Harvard University Maureen O'HaraCornell 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 SeriesDate posted: October 22, 2010 ; Last revised: January 31, 2011Suggested CitationContact Information
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