Market Stability vs. Market Resilience: Regulatory Policies Experiments in an Agent-Based Model with Low- and High-Frequency Trading

40 Pages Posted: 17 Apr 2016

See all articles by Sandrine Jacob Leal

Sandrine Jacob Leal

ICN Business School ; Université de Lorraine - CEREFIGE

Mauro Napoletano

Université de Nice Sophia Antipolis - Groupe de Recherche en Droit, Economie et Gestion (GREDEG); Observatoire Français des Conjonctures Economiques (OFCE); SKEMA Business School; Scuola Superiore Sant'Anna di Pisa - Laboratory of Economics and Management (LEM)

Date Written: April 1, 2016

Abstract

We investigate the effects of different regulatory policies directed towards high-frequency trading (HFT) through an agent-based model of a limit order book able to generate flash crashes as the result of the interactions between low- and high-frequency (HF) traders. We analyze the impact of the imposition of minimum resting times, of circuit breakers (both ex-post and ex-ante types), of cancellation fees and of transaction taxes on asset price volatility and on the occurrence and duration of flash crashes. In the model, low- frequency agents adopt trading rules based on chronological time and can switch between fundamentalist and chartist strategies. In contrast, high-frequency traders activation is event-driven and depends on price fluctuations. In addition, high-frequency traders employ low-latency directional strategies that exploit market information and they can cancel their orders depending on expected profits. Monte-Carlo simulations reveal that reducing HF order cancellation, via minimum resting times or cancellation fees, or discouraging HFT via financial transaction taxes, reduces market volatility and the frequency of flash crashes. However, these policies also imply a longer duration of flash crashes. Furthermore, the introduction of an ex-ante circuit breaker markedly reduces price volatility and removes flash crashes. In contrast, ex-post circuit breakers do not affect market volatility and they increase the duration of flash crashes. Our results show that HFT-targeted policies face a trade-off between market stability and resilience. Policies that reduce volatility and the incidence of flash crashes also imply a reduced ability of the market to quickly recover from a crash. The dual role of HFT, as both a cause of the flash crash and a fundamental actor in the post-crash recovery underlies the above trade-off.

Keywords: High-Frequency Trading, Flash Crashes, Regulatory Policies, Agent-Based Models, Limit Order Book, Market Volatility

JEL Classification: G12, G01, C63

Suggested Citation

Jacob Leal, Sandrine and Napoletano, Mauro, Market Stability vs. Market Resilience: Regulatory Policies Experiments in an Agent-Based Model with Low- and High-Frequency Trading (April 1, 2016). Available at SSRN: https://ssrn.com/abstract=2760996 or http://dx.doi.org/10.2139/ssrn.2760996

Sandrine Jacob Leal

ICN Business School ( email )

86 Rue du Sergent Blandan
Nancy, 54000
France

HOME PAGE: http://https://www.icn-artem.com/en/professeur/jacob-leal-sandrine

Université de Lorraine - CEREFIGE

23-25 Rue Baron Louis
Nancy, 54000
France

HOME PAGE: http://cerefige.univ-lorraine.fr/fr/membres/membres-titulaires/jacob-leal

Mauro Napoletano (Contact Author)

Université de Nice Sophia Antipolis - Groupe de Recherche en Droit, Economie et Gestion (GREDEG) ( email )

250, rue Albert Einstein
Valbonne, 06560
France

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

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