Would Position Limits Have Made any Difference to the 'Flash Crash' on May 6, 2010

On May 6, 2010, the US equity markets experienced a brief but highly unusual drop in prices across a number of stocks and indices. The Dow Jones Industrial Average (DJIA) fell by approximately 9% in a matter of minutes, and several stocks were traded down sharply before recovering a short time later...

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Main Authors: LEE, Wing Bernard, CHENG, Shih-Fen, KOH, Annie
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Language:English
Published: Institutional Knowledge at Singapore Management University 2010
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Online Access:https://ink.library.smu.edu.sg/sis_research/1333
https://ink.library.smu.edu.sg/context/sis_research/article/2332/viewcontent/FlashCrash6May_2011.pdf
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spelling sg-smu-ink.sis_research-23322017-11-19T13:42:28Z Would Position Limits Have Made any Difference to the 'Flash Crash' on May 6, 2010 LEE, Wing Bernard CHENG, Shih-Fen KOH, Annie On May 6, 2010, the US equity markets experienced a brief but highly unusual drop in prices across a number of stocks and indices. The Dow Jones Industrial Average (DJIA) fell by approximately 9% in a matter of minutes, and several stocks were traded down sharply before recovering a short time later. Earlier research by Lee, Cheng and Koh (2010) identified the conditions under which a “flash crash” can be triggered by systematic traders running highly similar trading strategies, especially when they are “crowding out” other liquidity providers in the market. The authors contend that the events of May 6, 2010 exhibit patterns consistent with the type of “flash crash” observed in their earlier study (2010). While some commentators assigned blame to high-frequency trading, the authors’ analysis was unable to identify a direct link to high-frequency trading per se, but rather the domination of market activities by trading strategies that are responding to the same set of market variables in similar ways, as well as various pre-existing market micro-structural safety mechanisms with unintended consequences when triggered simultaneously. The consequent lack of market participants interested in the “other side” of their trades may result in a significant liquidity withdrawal during extreme market movements. This paper describes the results of 9 different simulations created by using a large-scale computer model to reconstruct the critical elements of the market events of May 6, 2010. The resulting price distribution provides a reasonable resemblance to the descriptive statistics of the second-by-second prices of S&P500 e-Mini futures from 14:30 to 15:00 on May 6, 2010. There are no a priori assumptions made on asset price distributions, and our description of market dynamics is purely based on the structure of the market and the key types of market participants involved. This type of simulation avoids “over-fitting” historical data, and can therefore provide regulators with deeper insights on the possible drivers of the “flash crash”, as well as what type of policy responses may work or may not work under comparable market circumstances in the future. Our results also lead to a natural question for policy markers: If certain prescriptive measures such as position limits have a low probability of meeting its policy objectives on a day like May 6, will there be any other more effective counter measures without unintended consequences? 2010-11-01T07:00:00Z text application/pdf https://ink.library.smu.edu.sg/sis_research/1333 https://ink.library.smu.edu.sg/context/sis_research/article/2332/viewcontent/FlashCrash6May_2011.pdf http://creativecommons.org/licenses/by-nc-nd/4.0/ Research Collection School Of Computing and Information Systems eng Institutional Knowledge at Singapore Management University 6 May 2010 Flash Crash Liquidity Withdrawal Extreme Market Movements Agent-based Simulation Speculative Activities Position Limits Finance and Financial Management Numerical Analysis and Scientific Computing Portfolio and Security Analysis
institution Singapore Management University
building SMU Libraries
continent Asia
country Singapore
Singapore
content_provider SMU Libraries
collection InK@SMU
language English
topic 6 May 2010
Flash Crash
Liquidity Withdrawal
Extreme Market Movements
Agent-based Simulation
Speculative Activities
Position Limits
Finance and Financial Management
Numerical Analysis and Scientific Computing
Portfolio and Security Analysis
spellingShingle 6 May 2010
Flash Crash
Liquidity Withdrawal
Extreme Market Movements
Agent-based Simulation
Speculative Activities
Position Limits
Finance and Financial Management
Numerical Analysis and Scientific Computing
Portfolio and Security Analysis
LEE, Wing Bernard
CHENG, Shih-Fen
KOH, Annie
Would Position Limits Have Made any Difference to the 'Flash Crash' on May 6, 2010
description On May 6, 2010, the US equity markets experienced a brief but highly unusual drop in prices across a number of stocks and indices. The Dow Jones Industrial Average (DJIA) fell by approximately 9% in a matter of minutes, and several stocks were traded down sharply before recovering a short time later. Earlier research by Lee, Cheng and Koh (2010) identified the conditions under which a “flash crash” can be triggered by systematic traders running highly similar trading strategies, especially when they are “crowding out” other liquidity providers in the market. The authors contend that the events of May 6, 2010 exhibit patterns consistent with the type of “flash crash” observed in their earlier study (2010). While some commentators assigned blame to high-frequency trading, the authors’ analysis was unable to identify a direct link to high-frequency trading per se, but rather the domination of market activities by trading strategies that are responding to the same set of market variables in similar ways, as well as various pre-existing market micro-structural safety mechanisms with unintended consequences when triggered simultaneously. The consequent lack of market participants interested in the “other side” of their trades may result in a significant liquidity withdrawal during extreme market movements. This paper describes the results of 9 different simulations created by using a large-scale computer model to reconstruct the critical elements of the market events of May 6, 2010. The resulting price distribution provides a reasonable resemblance to the descriptive statistics of the second-by-second prices of S&P500 e-Mini futures from 14:30 to 15:00 on May 6, 2010. There are no a priori assumptions made on asset price distributions, and our description of market dynamics is purely based on the structure of the market and the key types of market participants involved. This type of simulation avoids “over-fitting” historical data, and can therefore provide regulators with deeper insights on the possible drivers of the “flash crash”, as well as what type of policy responses may work or may not work under comparable market circumstances in the future. Our results also lead to a natural question for policy markers: If certain prescriptive measures such as position limits have a low probability of meeting its policy objectives on a day like May 6, will there be any other more effective counter measures without unintended consequences?
format text
author LEE, Wing Bernard
CHENG, Shih-Fen
KOH, Annie
author_facet LEE, Wing Bernard
CHENG, Shih-Fen
KOH, Annie
author_sort LEE, Wing Bernard
title Would Position Limits Have Made any Difference to the 'Flash Crash' on May 6, 2010
title_short Would Position Limits Have Made any Difference to the 'Flash Crash' on May 6, 2010
title_full Would Position Limits Have Made any Difference to the 'Flash Crash' on May 6, 2010
title_fullStr Would Position Limits Have Made any Difference to the 'Flash Crash' on May 6, 2010
title_full_unstemmed Would Position Limits Have Made any Difference to the 'Flash Crash' on May 6, 2010
title_sort would position limits have made any difference to the 'flash crash' on may 6, 2010
publisher Institutional Knowledge at Singapore Management University
publishDate 2010
url https://ink.library.smu.edu.sg/sis_research/1333
https://ink.library.smu.edu.sg/context/sis_research/article/2332/viewcontent/FlashCrash6May_2011.pdf
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