Beyond the Flash Crash:Systemic Risk, Reliability, and High Frequency Financial Markets

Abstract

Extreme events in financial markets can arise from fundamental information, but they can also arise from latent hazards embedded in the market design. This concept is known as systemic risk, and someone must bear it. Extreme events add to risk, and their probability and severity must be accounted for by market participants. This article shows how this risk fits into the finance literature and that, from an engineering perspective, this risk in markets has never been lower. The industry is evolving to mitigate this risk. This article presents an overview of the complexity of the automated market network and describes how market participants interact through the exchange mechanism. It defines new terms and a new framework for understanding the risk of extreme market moves from a reliability and safety perspective.

TOPICS: Financial crises and financial market history, tail risks