High frequency traders in a simulated market
Abstract
Purpose
An agent-based market simulation is utilized to examine the impact of high frequency trading (HFT) on various aspects of the stock market. This study aims to provide a baseline understanding of the effect of HFT on markets by using a paradigm of zero-intelligence traders and examining the resulting structural changes.
Design/methodology/approach
A continuous double auction setting with zero-intelligence traders is used by adapting the model of Gode and Sunder (1993) to include algorithmic high frequency (HF) traders who retrade by marking up their shares by a fixed percentage. The simulation examines the effects of two independent factors, the number of HF traders and their markup percentage, on several dependent variables, principally volume, market efficiency, trader surplus and volatility. Results of the simulations are tested with two-way ANOVA and Tukey’s post hoc tests.
Findings
In the simulation results, trading volume, efficiency and total surplus vary directly with the number of traders employing HFT. Results also reveal that market volatility increased with the number of HF traders.
Research limitations/implications
Increases in volume, efficiency and total surplus represent market improvements due to the trading activities of HF traders. However, the increase in volatility is worrisome, and some of the surplus increase appears to come at the expense of long-term-oriented investors. However, the relatively recent development of HFT and dearth of appropriate data make direct calibration of any model difficult.
Originality/value
The simulation study focuses on the structural impact of HF traders on several aspects of the simulated market, with the effects isolated from other noise and problems with empirical data. A baseline for comparison and suggestions for future research are established.
Keywords
Citation
Hanson, T.A. (2016), "High frequency traders in a simulated market", Review of Accounting and Finance, Vol. 15 No. 3, pp. 329-351. https://doi.org/10.1108/RAF-02-2015-0023
Publisher
:Emerald Group Publishing Limited
Copyright © 2016, Emerald Group Publishing Limited