Agent-Based Model Exploration of Latency Arbitrage in Fragmented Financial Markets

Matthew Duffin, John Cartlidge*

*Corresponding author for this work

Research output: Chapter in Book/Report/Conference proceedingConference Contribution (Conference Proceeding)

5 Citations (Scopus)
218 Downloads (Pure)

Abstract

Computerisation of the financial markets has precipitated an arms-race for ever-faster trading. In combination, regulatory reform to encourage competition has resulted in market fragmentation, such that a single financial instrument can now be traded across multiple venues. This has led to the proliferation of high-frequency trading (HFT), and the ability to engage in latency arbitrage (taking advantage of accessing and acting upon price information before it is received by others). The impact of HFT and the consequences of latency arbitrage is a contentious issue. In 2013, Wah and Wellman used an agent-based model to study latency arbitrage in a fragmented market. They showed: (a) market efficiency is negatively affected by the actions of a latency arbitrageur; and (b) introducing a discrete-time call auction (DCA) eliminates latency arbitrage opportunities and improves efficiency. Here, we explore and extend Wah and Wellman's model, and demonstrate that results are sensitive to the bid-shading parameter used for zero-intelligence (ZIC) trading agents. To overcome this, we introduce the more realistic, minimally intelligent trading algorithm, ZIP. Using ZIP, we reach contrary conclusions: (a) fragmented markets benefit from latency arbitrage; and (b) DCAs do not improve efficiency. We present these results as evidence that the debate on latency arbitrage in financial markets is far from definitively settled, and suggest that ABM simulation - a form of decentralised collective computational intelligence - is a productive method for understanding and engineering financial systems.
Original languageEnglish
Title of host publication2018 IEEE Symposium Series on Computational Intelligence (SSCI 2018)
Subtitle of host publicationProceedings of a meeting held 18-21 November 2018, Bangalore, India
EditorsSuresh Sundaram
PublisherInstitute of Electrical and Electronics Engineers (IEEE)
Pages2312-2320
Number of pages9
ISBN (Electronic)9781538692769
ISBN (Print)9781538692776
DOIs
Publication statusPublished - Apr 2019
Event8th IEEE Symposium Series on Computational Intelligence, SSCI 2018 - Bangalore, India
Duration: 18 Nov 201821 Nov 2018

Conference

Conference8th IEEE Symposium Series on Computational Intelligence, SSCI 2018
CountryIndia
CityBangalore
Period18/11/1821/11/18

Keywords

  • Agent-Based Modelling
  • arbitrage
  • continuous Double Auction
  • discrete-time Call Auction
  • financial Markets
  • fragmentation
  • high-Frequency Trading
  • latency
  • zIC
  • zIP

Fingerprint Dive into the research topics of 'Agent-Based Model Exploration of Latency Arbitrage in Fragmented Financial Markets'. Together they form a unique fingerprint.

  • Profiles

    No photo of John P Cartlidge

    Dr John P Cartlidge

    Person: Academic

    Cite this

    Duffin, M., & Cartlidge, J. (2019). Agent-Based Model Exploration of Latency Arbitrage in Fragmented Financial Markets. In S. Sundaram (Ed.), 2018 IEEE Symposium Series on Computational Intelligence (SSCI 2018): Proceedings of a meeting held 18-21 November 2018, Bangalore, India (pp. 2312-2320). [8628638] Institute of Electrical and Electronics Engineers (IEEE). https://doi.org/10.1109/SSCI.2018.8628638