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Evolution and market behavior with endogenous investment rules

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  • Giulio Bottazzi
  • Pietro Dindo

Abstract

In a repeated market for short-lived assets, we investigate long run wealth-driven selection on the general class of investment rules that depend on endogenously determined current and past prices. We study the random dynamical system that describes the price and wealth dynamics and characterize local stability of long-run market equilibria. Instability, leading to asset mis-pricing and informational inefficiencies, turns out to be a common phenomenon generated by two different mechanisms. Firstly, conditioning investment decisions on asset prices implies that dominance of an investment rule on others, as measured by the relative entropy, can be different at different prevailing prices thus reducing the global selective capability of the market. Secondly, the feedback existing between past realized prices and current investment decisions can lead to a form of deterministic overshooting.

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Bibliographic Info

Paper provided by Laboratory of Economics and Management (LEM), Sant'Anna School of Advanced Studies, Pisa, Italy in its series LEM Papers Series with number 2010/20.

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Date of creation: 10 Nov 2010
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Handle: RePEc:ssa:lemwps:2010/20

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Related research

Keywords: Market Selection; Evolutionary Finance; Price Feedbacks; Asset Pricing; Informational Efficiency; Kelly rule.;

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References

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  1. Drèze,Jacques H. & Herings,P. Jean-Jacques, 2003. "Sequentially complete Markets Remain Incomplete," Research Memorandum 058, Maastricht University, Maastricht Research School of Economics of Technology and Organization (METEOR).
  2. Lawrence Blume & David Easley, 2001. "If You're So Smart, Why Aren't You Rich? Belief Selection in Complete and Incomplete Markets," Working Papers 01-06-031, Santa Fe Institute.
  3. Victor Ginsburgh & Michiel Keyzer, 2002. "The Structure of Applied General Equilibrium Models," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262571579, December.
  4. Hahn, F., 1992. "A Remark on Incomplete Market Equilibrium," Papers 179, Cambridge - Risk, Information & Quantity Signals.
  5. Sandroni, Alvaro, 2005. "Market selection when markets are incomplete," Journal of Mathematical Economics, Elsevier, vol. 41(1-2), pages 91-104, February.
  6. Blume, Lawrence & Easley, David, 1992. "Evolution and market behavior," Journal of Economic Theory, Elsevier, vol. 58(1), pages 9-40, October.
  7. Anufriev, Mikhail & Bottazzi, Giulio & Pancotto, Francesca, 2006. "Equilibria, stability and asymptotic dominance in a speculative market with heterogeneous traders," Journal of Economic Dynamics and Control, Elsevier, vol. 30(9-10), pages 1787-1835.
  8. Xue-Zhong (Tony) He & Carl Chiarella, 2001. "Asset Price and Wealth Dynamics under Heterogeneous Expectations," CeNDEF Workshop Papers, January 2001 5A.2, Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance.
  9. J. Doyne Farmer, 1999. "Market Force, Ecology, and Evolution," Computing in Economics and Finance 1999 651, Society for Computational Economics.
  10. Mikhail Anufriev & Pietro Dindo, 2007. "Wealth-driven Selection in a Financial Market with Heterogeneous Agents," LEM Papers Series 2007/27, Laboratory of Economics and Management (LEM), Sant'Anna School of Advanced Studies, Pisa, Italy.
  11. Armen A. Alchian, 1950. "Uncertainty, Evolution, and Economic Theory," Journal of Political Economy, University of Chicago Press, vol. 58, pages 211.
  12. Anufriev, Mikhail & Bottazzi, Giulio, 2010. "Market equilibria under procedural rationality," Journal of Mathematical Economics, Elsevier, vol. 46(6), pages 1140-1172, November.
  13. Alvaro Sandroni, 2000. "Do Markets Favor Agents Able to Make Accurate Predicitions?," Econometrica, Econometric Society, vol. 68(6), pages 1303-1342, November.
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Cited by:
  1. David K. Levine & Salvatore Modica & Federico Weinschelbaum & Felipe Zurita, 2012. "Evolving to the impatience trap: the example of the farmer-sheriff game," Working Papers 2012-033, Federal Reserve Bank of St. Louis.
  2. Giulio Bottazzi & Pietro Dindo, 2011. "Selection in asset markets: the good, the bad, and the unknown," LEM Papers Series 2011/11, Laboratory of Economics and Management (LEM), Sant'Anna School of Advanced Studies, Pisa, Italy.
  3. David K. Levine & Salvatore Modica, 2012. "Conflict and the evolution of societies," Working Papers 2012-032, Federal Reserve Bank of St. Louis.
  4. Carl Chiarella & Roberto Dieci & Xue-Zhong He, 2010. "Time-Varying Beta: A Boundedly Rational Equilibrium Approach," Research Paper Series 275, Quantitative Finance Research Centre, University of Technology, Sydney.
  5. Anufriev, Mikhail & Bottazzi, Giulio & Marsili, Matteo & Pin, Paolo, 2012. "Excess covariance and dynamic instability in a multi-asset model," Journal of Economic Dynamics and Control, Elsevier, vol. 36(8), pages 1142-1161.
  6. David K Levine & Salvatore Modica, 2013. "Conflict, Evolution, Hegemony, and the Power of the State," Levine's Working Paper Archive 786969000000000692, David K. Levine.
  7. David K. Levine & Salvatore Modica, 2013. "Conflict, evolution, hegemony, and the power of the state," Working Papers 2013-023, Federal Reserve Bank of St. Louis.

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