A simulation model of stock exchange trading

Abstract

A simulation model of stock exchange trading is used to test the impact of various stabilization policies on a stock's market per formance characteristics (price volatility, the size of its bid-ask spread, and autocorrelation patterns in the security's returns). Market participants include large and small traders, a pure stabilizer, and a speculating stabilizer. The "market architecture" includes the arrival of market and limit orders the maintenance of a limit order book, and the handling of trade execution. Each type of stabilizer improves the operating characteristics of the market, with the speculating stabilizer having a bigger impact and realizing more profits than the pure stabilizer. Using the mechanism of simulation to eliminate other sources of the stabilizer's profit, we find that stabilization per se is an un profitable activity. We then suggest additional ways in which the simulation model could be developed and further uses for it.