Order book microstructure and policies for financial stability

Abstract

Purpose The purpose of this paper is two-fold: first, to introduce an innovative model of financial order book, less simplified than the existing literature and still able to replicate all statistical features of true markets; second, to simulate realistically the effects of policies aimed to reduce the instability of financial markets. Design/methodology/approach The paper is based on an agent-based model and the applied methodology is the computational simulation. Findings The policymaker can actively reduce the instability of financial market by means of policies aimed to increase the heterogeneity of investors, both in terms of the behavioral attitude for market participation and of the differentiation of opinions; favor investors who show insensibility with regard to market information; limit the allowed number of counterparts for any market order; reduce the time validity of orders; and maintain flexibility and efficient bargaining, reduce transaction costs and avoid Tobin taxes. Research limitations/implications In future research, an opinion dynamics engine within a clustered community network will be embedded. Practical implications Indeed, the obtained results are policy rules which could be immediately applied. Originality/value The order book model contained in the paper is completely new, innovative and original. Innovativeness is based on a reduced number of simplifying assumptions. The realism of the presented mechanism is higher than in other existing models. The value of the model is high because of several factors. From the scientific point of view, it constitutes the reliable framework on which many other papers will be based: it is the core center of future research. From the policymaker’s point of view, it represents a credible tool for policy hypotheses testing.