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More Hedging Instruments may destablize Markets

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Author Info
William Brock () (University of Wisconsin, USA)
Cars Hommes () (Universiteit van Amsterdam)
Florian Wagener () (Universiteit van Amsterdam)

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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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Publisher 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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Related research
Keywords: Asset pricing; hedging; reinforcement learning; nonlinear dynamics; bifurcations;

Other versions of this item:

Find related papers by JEL classification:
D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search, Learning, and Information
D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Capital and Ownership Structure

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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!]
  3. Didier Sornette & Ryan Woodard, 2009. "Financial Bubbles, Real Estate bubbles, Derivative Bubbles, and the Financial and Economic Crisis," Quantitative Finance Papers 0905.0220, arXiv.org. [Downloadable!]
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