Spoofing the limit order book: a strategic agent-based analysis
Summary: We present an agent-based model of manipulating prices in financial markets through \textit{spoofing}: submitting spurious orders to mislead traders who learn from the order book. Our model captures a complex market environment for a single security, whose common value is given by a dynamic fundamental time series. Agents trade through a limit-order book, based on their private values and noisy observations of the fundamental. We consider background agents following two types of trading strategies: the non-spoofable \textit{zero intelligence} (ZI) that ignores the order book and the manipulable \textit{heuristic belief learning} (HBL) that exploits the order book to predict price outcomes. We conduct empirical game-theoretic analysis upon simulated agent payoffs across parametrically different environments and measure the effect of spoofing on market performance in approximate strategic equilibria. We demonstrate that HBL traders can benefit price discovery and social welfare, but their existence in equilibrium renders a market vulnerable to manipulation: simple spoofing strategies can effectively mislead traders, distort prices and reduce total surplus. Based on this model, we propose to mitigate spoofing from two aspects: (1) mechanism design to disincentivize manipulation; and (2) trading strategy variations to improve the robustness of learning from market information. We evaluate the proposed approaches, taking into account potential strategic responses of agents, and characterize the conditions under which these approaches may deter manipulation and benefit market welfare. Our model provides a way to quantify the effect of spoofing on trading behavior and market efficiency, and thus it can help to evaluate the effectiveness of various market designs and trading strategies in mitigating an important form of market manipulation.
- Spoofing and price manipulation in order-driven markets
- Order book resilience, price manipulation, and the positive portfolio problem
- On detecting spoofing strategies in high-frequency trading
- Characterising trader manipulation in a limit-order driven market
- Microstructure-based order placement in a continuous double auction agent based model
- Handbook of computational economics. Vol. 2: Agent-based computational economics
- Price formation in double auctions
- Strategic bidding in continuous double auctions
- The competitive market paradox
- Time series properties of an artificial stock market
- Welfare effects of market making in continuous double auctions
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