Effects of Limit Order Book Information Level on Market Stability Metrics

Using an agent-based model of the limit order book, we explore how the levels of information available to participants, exchanges, and regulators can be used to improve our understanding of the stability and resiliency of a market. Ultimately, we want to know if electronic market data contains previously undetected information that could allow us to better assess market stability. Using data produced in the controlled environment of an agent-based model’s limit order book, we examine various resiliency indicators to determine their predictive capabilities. Most of the types of data created have traditionally been available either publicly or on a restricted basis to regulators and exchanges, but other types have never been collected. We confirmed our findings using actual order flow data with user identifications included from the CME (Chicago Mercantile Exchange) and New York Mercantile Exchange (NYMEX). Our findings strongly suggest that high-fidelity microstructure data in combination with price data can be used to define stability indicators capable of reliably signaling a high likelihood for an imminent flash crash event about one minute before it occurs. Acknowledgments: The authors are very grateful to Philip Maymin, Michael Wellman, Nathan Palmar, Greg Feldberg and Wendy Wagner-Smith for their help and guidance with this paper. Special acknowledgement is due Andrew Todd for his help in the development of the agent-based simulation used in this paper. The research presented in this paper was authored by Mark Paddrik, Roy Hayes, William Scherer, Peter Beling, former contractors for the Commodity Futures Trading Commission (CFTC) who worked under CFTC OCE contract. The Office of the Chief Economist and CFTC economists produce original research on a broad range of topics relevant to the CFTC’s mandate to regulate commodity futures markets, commodity options markets, and the expanded mandate to regulate the swaps markets under the Dodd-Frank Wall Street Reform and Consumer Protection Act. These papers are often presented at conferences and many of these papers are later published by peer-review and other scholarly outlets. The analyses and conclusions expressed in this paper are those of the authors and do not reflect the views of other members of the Office of the Chief Economist, other Commission staff, or the Commission itself.