The October 2016 Sterling Flash Episode: When Liquidity Disappeared from One of the World's Most Liquid Markets

Abstract

This paper provides an in-depth analysis of the evolution of liquidity during the flash episode in sterling during the early hours of 7 October 2016. It examines a number of estimates both of the cost of trading, and the price impact of executed transactions. These include a variant of the ‘volatility over volume’ measure of liquidity based on transaction data, which provides a better proxy of illiquidity — as given by measures based on high-frequency limit order book data — than other summary measures of price impact. The paper also shows that the fall in the value of sterling during the initial part of the flash episode was consistent with the estimated impact on prices of a large number of individually small — but in aggregate large — volume of orders to sell sterling during a normally quiet period of the trading day. However, the subsequent change in price was larger than that consistent with the estimated impact on prices of observed orders to sell sterling. This might support the suggestion, which was included in the report on the episode provided by the Bank for International Settlements, that the move in sterling may have been amplified by the pause in trading on the CME futures exchange.

Keywords: Flash Crash, Foreign Exchange Market, Liquidity, Price Impact

JEL Classification: F33, F37, G01, G12, G15