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Learning and Adaptation as a Source of Market Failure

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Abstract

In the developed model, without knowing the trading strategies of the other traders in a financial market, traders cannot derive a rational expectations equilibrium. In a dynamic setting, market participants employ learning and adaptation to develop trading strategies to accommodate for this information de ficiency. Model-consistent use of market-based information generally improves price performance. It can also produce episodes of extreme sudden mispricing despite model generated historical support for its use. Simulations examine the impact of information constraints and bounded rationality on general price efficiency and sudden market mispricing.

Suggested Citation

  • David Goldbaum, 2013. "Learning and Adaptation as a Source of Market Failure," Working Paper Series 14, Economics Discipline Group, UTS Business School, University of Technology, Sydney.
    • Handle: RePEc:uts:ecowps:14
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    File URL: http://www.uts.edu.au/sites/default/files/edg_wp14.pdf
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    More about this item

    Keywords

    Heterogeneous Agents; Efficient Markets; Learning; Dynamics; Computational Economics; Market Failure;
    All these keywords.

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • C62 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Existence and Stability Conditions of Equilibrium
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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