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



Type:   Working paper
Titre:   Market Stability vs. Market Resilience: Regulatory Policies Experiments in an Agent-Based Model with Low- and High- Frequency Trading
Auteur(s):   Jacob Leal, Sandrine - Groupe de Recherche en Droit, Economie et Gestion (Auteur)
Napoletano, Mauro (1977-...) - Observatoire français des conjonctures économiques (Auteur)
Date de publication:   2016-04
Éditeur:   Paris  :  Observatoire français des conjonctures économiques
Collection:   Working paper de l'OFCE  :  2016-12
Mots-clés:   [en] High frequency trade, Flash crashes, Regulatory policies, Agent-based models, Limit order book, Market volatility
JEL:   G12,  G01,  C63
Résumé:   [en] 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 ash 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 ash 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 ash 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-o 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 .


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