Rock Around the Clock: An Agent-Based Model of Low- and High-Frequency Trading

25 Pages Posted: 5 Feb 2014  

Sandrine Jacob Leal

ICN Business School (Nancy-Metz) France

Mauro Napoletano

Observatoire Français des Conjonctures Economiques (OFCE); SKEMA Business School; Scuola Superiore Sant'Anna di Pisa - Laboratory of Economics and Management (LEM)

Andrea Roventini

Scuola Superiore Sant'Anna di Pisa - Laboratory of Economics and Management (LEM); Observatoire Français des Conjonctures Economiques (OFCE)

Giorgio Fagiolo

Scuola Superiore Sant'Anna di Pisa - Laboratory of Economics and Management (LEM)

Date Written: January 31, 2014

Abstract

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 fluctuations. High-frequency traders use directional strategies to exploit market information produced by low-frequency traders. Monte-Carlo simulations reveal that the model replicates the main stylized facts of financial markets. Furthermore, we find 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 find that higher rates of order cancellation by high-frequency traders increase the incidence of flash crashes but reduce their duration.

Keywords: Agent-based models, Limit order book, High-frequency trading, Low- frequency trading, Flash crashes, Market volatility

JEL Classification: G12, G01, C63

Suggested Citation

Jacob Leal, Sandrine and Napoletano, Mauro and Roventini, Andrea and Fagiolo, Giorgio, Rock Around the Clock: An Agent-Based Model of Low- and High-Frequency Trading (January 31, 2014). Available at SSRN: https://ssrn.com/abstract=2390682 or http://dx.doi.org/10.2139/ssrn.2390682

Sandrine Jacob Leal (Contact Author)

ICN Business School (Nancy-Metz) France ( email )

13 rue du Michel Ney
Nancy, 54000
France

HOME PAGE: http://www.icn-groupe.fr/en/faculty--research/faculty/finance-audit-accounting-and-control/jacob-lea

Mauro Napoletano

Observatoire Français des Conjonctures Economiques (OFCE) ( email )

60, rue Dostoïevski
Sophia-Antipolis Cedex, 06902
France

HOME PAGE: http://www.ofce.sciences-po.fr

SKEMA Business School ( email )

60 rue Dostoïevski
Sophia Antipolis, 06902
France

Scuola Superiore Sant'Anna di Pisa - Laboratory of Economics and Management (LEM) ( email )

Piazza Martiri della Liberta, 33
Pisa, I-56127
Italy

Andrea Roventini

Scuola Superiore Sant'Anna di Pisa - Laboratory of Economics and Management (LEM) ( email )

Piazza Martiri della Liberta', 33-I-56127
Pisa
Italy

Observatoire Français des Conjonctures Economiques (OFCE) ( email )

69 Quai d'Orsay
Paris 75004
France

Giorgio Fagiolo

Scuola Superiore Sant'Anna di Pisa - Laboratory of Economics and Management (LEM) ( email )

Piazza Martiri della Liberta', 33-I-56127
Pisa
Italy

Paper statistics

Downloads
389
Rank
60,715
Abstract Views
1,962