The Effects of High Frequency Traders in a Simulated Market

26 Pages Posted: 15 Sep 2011  

Thomas A. Hanson

Kent State University - Department of Finance

Date Written: August 28, 2011

Abstract

High frequency trading (HFT) is the latest revolutionary force in financial markets, but good empirical data is notoriously difficult to obtain and analyze. To provide some basic insights into the effects of HFT on stock markets, this paper employs an agent-based simulation to examine the influence of a simple HFT strategy in a continuous double auction market. In the simulated market environment, market liquidity, efficiency, and total surplus each varied directly with the number of traders employing the HFT strategy, thereby strengthening the arguments of some proponents of HFT. However, results supported that market volatility increased with the number of HF traders, and the profits of those traders may come at the expense of long-term oriented investors. These findings may justify some of the concerns of regulators. The simulation setting helps isolate the effect of HFT, and the results bear further testing and validation in empirical markets.

Keywords: high frequency trading, agent-based simulation, market efficiency, price volatility, regulation

Suggested Citation

Hanson, Thomas A., The Effects of High Frequency Traders in a Simulated Market (August 28, 2011). Midwest Finance Association 2012 Annual Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1918570 or http://dx.doi.org/10.2139/ssrn.1918570

Thomas A. Hanson (Contact Author)

Kent State University - Department of Finance ( email )

College of Business Administration
P.O. Box 5190
Kent, OH 44242-0001
United States

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