Mark Van Achter

Circuit Breakers and Market Runs

This paper analyzes whether the application of a “circuit breaker” to a financial market (i.e. a mechanism that interrupts trading for a predetermined period when the price moves beyond a predetermined level) reaches its intended goals of increased market stability and overall welfare. Our framework of analysis is a model in which investors can trade at several dates and might face a liquidity shock forcing them to sell immediately when the shock occurs. This setting potentially induces a “market run” where investors commonly sell merely out of fear other investors are selling and not because they have current liquidity needs. We show that the introduction of a sufficiently tightly-set circuit breaker within this setting successfully prevents this market run from occurring. Even more so, it could induce the socially optimal state (in which trading only takes place when it is motivated by liquidity needs) to arise. However, this desirable equilibrium can only be reached under particular economic conditions. When these conditions are not met, installing a circuit breaker might even lower social welfare as compared to a setting without a circuit breaker as it impedes socially desirable trades and stimulates socially undesirable trades.

High-Frequency Trading and Market Stability

StrategyDesk lets you create, test and execute your stock trading strategy — all using one powerful, downloadable desktop application. In just a few clicks, you can define strategy entry and exit rules, test your rules against historical market data and then activate them for live trading. You also get advanced charting and real-time screening capabilities to help you find, analyze and act on potential trading opportunities.We analyze how liquidity provision by high-frequency traders (HFTs) affects market stability, echoing recent regulatory concerns. Our model features a limit order market with informed trading and endogenous entry and exit. Liquidity is provided by traditional liquidity providers and HFTs with superior speed and/or information processing technology. Speed technology by itself leads to efficient resource allocation and maximizes liquidity. Information processing technology by itself generates mild inefficiencies due to a lemons problem. Yet, the combination of the two can lead to the implementation of inefficient speed technology, oligopolistic rents, or an amplified lemons problem with occasional market freezes.