Rock around the Clock: An Agent-Based Model of Low- and High-Frequency Trading
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.
- Publication:
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arXiv e-prints
- Pub Date:
- February 2014
- DOI:
- 10.48550/arXiv.1402.2046
- arXiv:
- arXiv:1402.2046
- Bibcode:
- 2014arXiv1402.2046L
- Keywords:
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- Quantitative Finance - Trading and Market Microstructure
- E-Print:
- 11 pages, 10 figures, 4 tables