We present an agent-based model of manipulating prices in financial markets through 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 zero intelligence (ZI) that ignores the order book and the manipulable 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.
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Get real: realism metrics for robust limit order book market simulations
Market simulation is an increasingly important method for evaluating and training trading strategies and testing "what if" scenarios. The extent to which results from these simulations can be trusted depends on how realistic the environment is for the strategies being tested. As a step towards providing benchmarks for realistic simulated markets, we enumerate measurable stylized facts of limit order book (LOB) markets across multiple asset classes from the literature. We apply these metrics to data from real markets and compare the results to data originating from simulated markets. We illustrate their use in five different simulated market configurations: The first (market replay) is frequently used in practice to evaluate trading strategies; the other four are interactive agent based simulation (IABS) configurations which combine zero intelligence agents, and agents with limited strategic behavior. These simulated agents rely on an internal "oracle" that provides a fundamental value for the asset. In traditional IABS methods the fundamental originates from a mean reverting random walk. We show that markets exhibit more realistic behavior when the fundamental arises from historical market data. We further experimentally illustrate the effectiveness of IABS techniques as opposed to market replay.
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- Award ID(s):
- 1741026
- PAR ID:
- 10311499
- Date Published:
- Journal Name:
- ICAIF '20: Proceedings of the First ACM International Conference on AI in Finance
- Format(s):
- Medium: X
- Sponsoring Org:
- National Science Foundation
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We study learning-based trading strategies in markets where prices can be manipulated through spoofing: the practice of submitting spurious orders to mislead traders who use market information. To reduce the vulnerability of learning traders to such manipulation, we propose two variations based on the standard heuristic belief learning (HBL) trading strategy, which learns transaction probabilities from market activities observed in an order book. The first variation selectively ignores orders at certain price levels, particularly where spoof orders are likely to be placed. The second considers the full order book, but adjusts its limit order price to correct for bias in decisions based on the learned heuristic beliefs. We employ agent-based simulation to evaluate these variations on two criteria: effectiveness in non-manipulated markets and robustness against manipulation. Background traders can adopt the (non-learning) zero intelligence strategies or HBL, in its basic form or the two variations. We conduct empirical game-theoretic analysis upon simulated payoffs to derive approximate strategic equilibria, and compare equilibrium outcomes across a variety of trading environments. Results show that agents can strategically make use of the option to block orders to improve robustness against spoofing, while retaining a comparable competitiveness in non-manipulated markets. Our second HBL variation exhibits a general improvement over standard HBL, in markets with and without manipulation. Further explorations suggest that traders can enjoy both improved profitability and robustness by combining the two proposed variations.more » « less
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- Free Publicly Accessible Full Text
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Accepted Manuscript1.0
- Conference Paper:
- https://doi.org/10.1145/3383455.3422561
