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Information Flow, Social Interactions and the Fluctuations of Prices in Financial Markets

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  • João Amaro de Matos

Abstract

We model how excess demand or excess supply can be generated in the presence of a social network of interactions, where agents are subject to external information and individual incentives. In this context we study price fluctuations in financial markets under equilibrium. In particular, we isolate the role of these different factors in the determination of price fluctuations and describe non trivial sensitivities to changes in equilibrium due to the existence of social interactions. We characterize equilibrium and distinguish between stable and unstable equilibrium. Crashes or bubbles are seen as out-of-equilibrium situations, preceeded by unstable equilibrium. Fluctuations under unstable equilibrium are shown to be abnormal and particulary large. Also, we show how fluctuations of the external information flows affect the fluctuations of the return process. In all cases we explain the well-known phenomena that prices do not fluctuate upwards in the same way as they fluctuate downwards. This asymmetry of price fluctuations is due to asymmetries in the price elasticity of demand and supply curves at the level defining equilibrium

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File URL: http://repec.org/esLATM04/up.5234.1081795414.pdf
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Bibliographic Info

Paper provided by Econometric Society in its series Econometric Society 2004 Latin American Meetings with number 114.

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Date of creation: 11 Aug 2004
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Handle: RePEc:ecm:latm04:114

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Keywords: social network; excess demand; excess supply; price fluctuations;

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  1. W. A. Brock, 1993. "Pathways to Randomness in the Economy: Emergent Nonlinearity and Chaos in Economics and Finance," Working Papers 93-02-006, Santa Fe Institute.
  2. Brock, William A & Durlauf, Steven N, 2001. "Discrete Choice with Social Interactions," Review of Economic Studies, Wiley Blackwell, vol. 68(2), pages 235-60, April.
  3. Steven N. Durlauf, 1992. "A Theory of Persistent Income Inequality," NBER Working Papers 4056, National Bureau of Economic Research, Inc.
  4. William A. Brock & Cars H. Hommes, 1997. "A Rational Route to Randomness," Econometrica, Econometric Society, vol. 65(5), pages 1059-1096, September.
  5. Blume Lawrence E., 1993. "The Statistical Mechanics of Strategic Interaction," Games and Economic Behavior, Elsevier, vol. 5(3), pages 387-424, July.
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