High Frequency Trading and Mini Flash Crashes

We analyse all Mini Flash Crashes (or Flash Equity Failures) in the US equity markets in the four most volatile months during 2006-2011. In contrast to previous studies, we find that Mini Flash Crashes are the result of regulation framework and market fragmentation, in particular due to the aggressive use of Intermarket Sweep Orders and Regulation NMS protecting only Top of the Book. We find strong evidence that Mini Flash Crashes have an adverse impact on market liquidity and are associated with Fleeting Liquidity

Realizing stock market crashes: stochastic cusp catastrophe model of returns under the time-varying volatility

This paper develops a two-step estimation methodology, which allows us to apply catastrophe theory to stock market returns with time-varying volatility and model stock market crashes. Utilizing high frequency data, we estimate the daily realized volatility from the returns in the first step and use stochastic cusp catastrophe on data normalized by the estimated volatility in the second step to study possible discontinuities in markets. We support our methodology by simulations where we also discuss the importance of stochastic noise and volatility in deterministic cusp catastrophe model. The methodology is empirically tested on almost 27 years of U.S. stock market evolution covering several important recessions and crisis periods. Due to the very long sample period we also develop a rolling estimation approach and we find that while in the first half of the period stock markets showed marks of bifurcations, in the second half catastrophe theory was not able to confirm this behavior. Results suggest that the proposed methodology provides an important shift in application of catastrophe theory to stock markets

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

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

Heterogeneous criticality in high frequency finance: a phase transition in flash crashes

Flash crashes in financial markets have become increasingly important, attracting attention from financial regulators, market makers as well as from the media and the broader audience. Systemic risk and the propagation of shocks in financial markets is also a topic of great relevance that has attracted increasing attention in recent years. In the present work, we bridge the gap between these two topics with an in-depth investigation of the systemic risk structure of co-crashes in high frequency trading. We find that large co-crashes are systemic in their nature and differ from small ones. We demonstrate that there is a phase transition between co-crashes of small and large sizes, where the former involves mostly illiquid stocks, while large and liquid stocks are the most represented and central in the latter. This suggests that systemic effects and shock propagation might be triggered by simultaneous withdrawals or movement of liquidity by HFTs, arbitrageurs and market makers with cross-asset exposures

The flash crash: high-frequency trading in an electronic market

© 2017 the American Finance Association We study intraday market intermediation in an electronic market before and during a period of large and temporary selling pressure. On May 6, 2010, U.S. financial markets experienced a systemic intraday event—the Flash Crash—where a large automated selling program was rapidly executed in the E-mini S&P 500 stock index futures market. Using audit trail transaction-level data for the E-mini on May 6 and the previous three days, we find that the trading pattern of the most active nondesignated intraday intermediaries (classified as High-Frequency Traders) did not change when prices fell during the Flash Crash