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The virtues and vices of equilibrium and the future of financial economics

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  • J. Doyne Farmer
  • John Geanakoplos

Abstract

The use of equilibrium models in economics springs from the desire for parsimonious models of economic phenomena that take human reasoning into account. This approach has been the cornerstone of modern economic theory. We explain why this is so, extolling the virtues of equilibrium theory; then we present a critique and describe why this approach is inherently limited, and why economics needs to move in new directions if it is to continue to make progress. We stress that this shouldn't be a question of dogma, but should be resolved empirically. There are situations where equilibrium models provide useful predictions and there are situations where they can never provide useful predictions. There are also many situations where the jury is still out, i.e., where so far they fail to provide a good description of the world, but where proper extensions might change this. Our goal is to convince the skeptics that equilibrium models can be useful, but also to make traditional economists more aware of the limitations of equilibrium models. We sketch some alternative approaches and discuss why they should play an important role in future research in economics.

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Paper provided by arXiv.org in its series Papers with number 0803.2996.

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Date of creation: Mar 2008
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Handle: RePEc:arx:papers:0803.2996

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Citations

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Cited by:
  1. Blake LeBaron, 2010. "Heterogeneous Gain Learning and the Dynamics of Asset Prices," Working Papers 29, Brandeis University, Department of Economics and International Businesss School, revised Dec 2010.
  2. Gaël Giraud & Nguenamadji Orntangar, 2011. "Monetary policy under finite speed of trades and myopia," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) halshs-00609824, HAL.
  3. Lotz, Aileen & Gosselin, Pierre, 2012. "A dynamic model of interactions between conscious and unconscious," MPRA Paper 36697, University Library of Munich, Germany.
  4. Brock, W.A. & Hommes, C.H. & Wagener, F.O.O., 2008. "More hedging instruments may destabilize markets (Revised version, April 2008)," CeNDEF Working Papers 08-04, Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance.
  5. Hawkins, Raymond J. & Aoki, Masanao & Roy Frieden, B., 2010. "Asymmetric information and macroeconomic dynamics," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 389(17), pages 3565-3571.
  6. Samuel E. Vazquez, 2009. "Scale Invariance, Bounded Rationality and Non-Equilibrium Economics," Papers 0902.3840, arXiv.org.
  7. Gaël Giraud & Nguenamadji Orntangar, 2011. "Monetary policy under finite speed of trades and myopia," Post-Print halshs-00609824, HAL.
  8. Jean-Philippe Bouchaud, 2011. "Panel Statement: The endogenous dynamics of markets: price impact and feedback loops," Chapters, European Central Bank.
  9. Lee Smolin, 2009. "Time and symmetry in models of economic markets," Papers 0902.4274, arXiv.org.

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