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More hedging instruments may destabilize markets

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Author Info
Brock, W.A.
Hommes, C.H.
Wagener, F.O.O.

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Abstract

This paper formalizes the idea that more hedging instruments may destabilize markets when traders have heterogeneous expectations and adapt their behavior according to performance-based reinforcement learning. In a simple asset pricing model with heterogeneous beliefs the introduction of additional Arrow securities may destabilize markets, and thus increase price volatility, and at the same time decrease average welfare. We also investigate whether a fully rational agent can employ additional hedging instruments to stabilize markets. It turns out that the answer depends on the composition of the population of non-rational traders and the information gathering costs for rationality.

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Publisher Info
Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 33 (2009)
Issue (Month): 11 (November)
Pages: 1912-1928
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Handle: RePEc:eee:dyncon:v:33:y:2009:i:11:p:1912-1928

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Related research
Keywords: Financial innovation Asset pricing Hedging Reinforcement learning Bifurcations;

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References listed on IDEAS
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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Valentyn Panchenko & Sergiy Gerasymchuk & Oleg V. Pavlov, 2007. "Asset price dynamics with small world interactions under hetereogeneous beliefs," Working Papers 149, Department of Applied Mathematics, University of Venice. [Downloadable!]
  2. Sergiy Gerasymchuk, 2008. "Asset return and wealth dynamics with reference dependent preferences and heterogeneous beliefs," Working Papers 160, Department of Applied Mathematics, University of Venice. [Downloadable!]
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