The Evolution of Security Designs
AbstractWe consider a competitive and perfect financial market in which agents have heterogeneous cash flow valuations. Instead of assuming that agents are endowed with rational expectations, we model their behavior as the product of adaptive learning. Our results demonstrate that adaptive learning affects security design profoundly, with securities mispriced even in the long run and optimal designs trading off underpricing against intrinsic value maximization. The evolutionary dominant security design calls for issuing securities that engender large losses with a small but positive probability, but that otherwise produce stable payoffs, almost the exact opposite of the pure state claims that are optimal in the rational expectations framework. Copyright 2006 by The American Finance Association.
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Bibliographic InfoArticle provided by American Finance Association in its journal The Journal of Finance.
Volume (Year): 61 (2006)
Issue (Month): 5 (October)
Other versions of this item:
- Noe, Thomas H. & Rebello, Michael J. & Wang, Jun, 2004. "The Evolution of Security Designs," SIFR Research Report Series, Institute for Financial Research 26, Institute for Financial Research.
- C45 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Neural Networks and Related Topics
- D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search, Learning, and Information
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
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