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The deeds of speed: an agent-based model of market liquidity and flash episodes

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  • Karvik, Geir-Are

    (Bank of England)

  • Noss, Joseph

    (Bank of England)

  • Worlidge, Jack

    (Bank of England)

  • Beale, Daniel

    (Bank of England)

Abstract

This paper examines the role of high-frequency traders in flash episodes in electronic financial markets. To do so, we construct an agent-based model of a market for a financial asset in which trading occurs through a central limit order book. The model consists of heterogeneous agents with different trading strategies and frequencies, and is calibrated to high-frequency time series data on the sterling-US dollar exchange rate. Flash episodes occur in the model due to the procyclical behaviour of high-frequency market participants. This is aligned with some empirical evidence as to the drivers of real-world flash crashes. We find that the prevalence of flash episodes increases with the frequency with which high-frequency market participants trade compared to their low-frequency counterparts. This provides tentative theoretical evidence that the recent growth in high-frequency trading across some markets has led to flash episodes. Furthermore, we adapt the model so that large movements in price trigger temporary halts in trading (ie circuit breakers). This is found to reduce the magnitude and frequency of flash episodes.

Suggested Citation

  • Karvik, Geir-Are & Noss, Joseph & Worlidge, Jack & Beale, Daniel, 2018. "The deeds of speed: an agent-based model of market liquidity and flash episodes," Bank of England working papers 743, Bank of England.
    • Handle: RePEc:boe:boeewp:0743
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    References listed on IDEAS

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    Cited by:

    1. Romain Plassard, 2020. "Making a Breach: The Incorporation of Agent-Based Models into the Bank of England's Toolkit," GREDEG Working Papers 2020-30, Groupe de REcherche en Droit, Economie, Gestion (GREDEG CNRS), Université Côte d'Azur, France.
    2. Xin Guan & Takanobu Mizuta & Isao Yagi, 2024. "Impact of arbitrage trading between an ETF and its underlying assets on market liquidity of their markets using an agent-based simulation," Journal of Computational Social Science, Springer, vol. 7(3), pages 2839-2870, December.

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    More about this item

    Keywords

    Agent-based modelling; high-frequency trading; financial stability; market liquidity; flash episodes; principal trading firms (PTFs);
    All these keywords.

    JEL classification:

    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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