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More Hedging Instruments may destablize Markets

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  • William Brock

    ()
    (University of Wisconsin, USA)

  • Cars Hommes

    ()
    (Universiteit van Amsterdam)

  • Florian Wagener

    ()
    (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 Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 06-080/1.

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Date of creation: 22 Sep 2006
Date of revision: 30 Apr 2008
Handle: RePEc:dgr:uvatin:20060080

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Keywords: Asset pricing; hedging; reinforcement learning; nonlinear dynamics; bifurcations;

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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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