Abstract: In this paper we propose an artificial market to model high frequency trading where (fast) agents strategically use thresholds rules to issue orders based on a signal on the level of stochastic liquidity prevailing on the market. A (slow) market maker is in charge to daily set the closing price and adjust transaction costs to control for the volatility of returns and market activity.
We first show that a baseline version of the model with no frictions is able to generate returns endowed with several stylized facts, thus suggesting that the two time-scales used in the model are one (and possibly novel) way to obtain realistic market outcomes and that high-frequency trading can amplify liquidity shocks. We then explore whether transaction costs can be used to control excess volatility and improve market quality. While properly imple- mented taxation schemes may help in reducing the volatility, care is needed to avoid to excessively reduce activity in the market and intensify the occurence of abnormal peaks in returns.
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