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More hedging instruments may destabilize markets

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  • Brock, W.A.

    (University of Wisconsin)

  • Hommes, C.H.

    (Universiteit van Amsterdam)

  • Wagener, F.O.O.

    ()
    (Universiteit van Amsterdam)

Abstract

This paper formalizes the idea that more hedging instruments may destabilize markets when traders are heterogeneous and adapt their behavior according to experience based reinforcement learning. We investigate three different economic settings, a simple mean-variance asset pricing model, a general equilibrium two-period overlapping generations model with heterogeneous expectations and a noisy rational expectations asset pricing model with heterogeneous information signals. In each setting the introduction of additional Arrow securities can destabilize the market, causing a bifurcation of the steady state to multiple steady states, periodic orbits or even chaotic fluctuations.

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Bibliographic Info

Paper provided by Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance in its series CeNDEF Working Papers with number 06-12.

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Date of creation: 2006
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Handle: RePEc:ams:ndfwpp:06-12

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  1. Efficiency versus stability
    by Mark Buchanan in The Physics of Finance on 2011-08-24 16:42:00
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