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

Author

Listed:
  • Sandrine Jacob Leal

    (CEREFIGE - ICN Business School (Nancy-Metz)
    GREDEG CNRS)

  • Mauro Napoletano

    (OFCE and SKEMA Business School, Sophia-Antipolis (France)
    Scuola Superiore Sant'Anna, Pisa (Italy))

  • Andrea Roventini

    (University of Verona (Italy)
    Scuola Superiore Sant'Anna, Pisa (Italy)
    OFCE and SKEMA Business School, Sophia-Antipolis (France))

  • Giorgio Fagiolo

    (Scuola Superiore Sant'Anna, Pisa (Italy))

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 in-formation 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.

Suggested Citation

  • Sandrine Jacob Leal & Mauro Napoletano & Andrea Roventini & Giorgio Fagiolo, 2014. "Rock around the Clock: An Agent-Based Model of Low- and High-Frequency Trading," GREDEG Working Papers 2014-21, Groupe de REcherche en Droit, Economie, Gestion (GREDEG CNRS), Université Côte d'Azur, France.
    • Handle: RePEc:gre:wpaper:2014-21
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    Agent-based models; Limit order book; High-frequency trading; Low-frequency trading; Flash crashes; Market volatility;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G01 - Financial Economics - - General - - - Financial Crises
    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques

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