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

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

15 Pages Posted: 21 May 2019 Last revised: 31 Jan 2011

See all articles by David Easley

David Easley

Cornell University - Department of Economics; Cornell University - Department of Information Science

Marcos Lopez de Prado

Cornell University - Operations Research & Industrial Engineering; Abu Dhabi Investment Authority; True Positive Technologies

Maureen O'Hara

Cornell University - Samuel Curtis Johnson Graduate School of Management; Cornell SC Johnson College of Business

Date Written: November 19, 2010

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.

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

JEL Classification: C02, D52, D53, G14

Suggested Citation

Easley, David and López de Prado, Marcos and López 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: https://ssrn.com/abstract=1695041 or http://dx.doi.org/10.2139/ssrn.1695041

David Easley (Contact Author)

Cornell University - Department of Economics ( email )

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Cornell University - Department of Information Science ( email )

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Marcos López de Prado

Abu Dhabi Investment Authority ( email )

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United Arab Emirates

HOME PAGE: http://www.adia.ae

Cornell University - Operations Research & Industrial Engineering ( email )

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HOME PAGE: http://www.orie.cornell.edu

True Positive Technologies ( email )

NY
United States

HOME PAGE: http://www.truepositive.com

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)

Cornell SC Johnson College of Business ( email )

Ithaca, NY 14850
United States

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