The Flash Crash: A Cautionary Tale About Highly Fragmented Markets

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Abstract
A breakdown of cross-market arbitrage activity could make markets more fragile and result in price crashes. We provide suggestive evidence for this novel channel based on a high-frequency analysis of the most salient crash in recent history: The Flash Crash. We further show that such an event can be extremely costly for a large seller trading in a particular venue as the seller effectively relies on local liquidity supply only. These findings highlight the vulnerability of today’s highly fragmented markets. The online appendix is available at https://doi.org/10.1287/mnsc.2018.3040. This paper was accepted by Gustavo Manso, finance.