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A Flash Crash Simulator:
Yoshiharu Sato
Invited Seminar, Quantitative Finance Research Group, University of Warsaw
Working Paper
Figure 1: Our limit order book (LOB) matching engine and simulator in action - Limit, market, and cancellation orders are automatically submitted to the LOB using a zero-intelligence model, and a flash crash is artificially created by continuously submitting market sell orders, thereby causing a significant order flow imbalance.
Abstract
A 2014 CFTC report has concluded that the 2010 Flash Crash was not caused by high-frequency traders but was exacerbated by them with their market-making strategy known as the electronic liquidity provision (ELP). This paper presents a computational analysis of the impact of ELP-HFTs on core market quality during a flash crash. Specifically examined is how ELP-HFTs affect the attributes of core market quality such as liquidity, bid-ask spreads, and short-term price volatility. To investigate the question, we build a zero-intelligence limit order book (LOB) simulator from scratch, implement the ELP strategy in it, and execute simulations in which a flash crash is artificially created. Our results show that ELP-HFTs reduce bid-ask spreads, mitigate short-term volatility, and increase total trade volume. The increase in total trade volume is attributed to what is known as the “hot-potato” effect, which was also observed during the 2010 Flash Crash. However, we conclude that the ELP strategy by itself does not amplify directional price moves despite hot-potato effects.
Keywords: Algorithmic Trading, High-Frequncy Trading, Market Making, Limit Order Book, Flash Crash, Quantitative Finance, Concurrent Programming
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