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More hedging instruments may destabilize markets

Author Info

  • Brock, W.A.

    (University of Wisconsin)

  • Hommes, C.H.

    (Universiteit van Amsterdam)

  • Wagener, F.O.O.

    ()

    (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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Paper provided by Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance in its series CeNDEF Working Papers with number 06-12.

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Date of creation: 2006
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Handle: RePEc:ams:ndfwpp:06-12
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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; Information and Knowledge; Communication; Belief; Unawareness
  • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
  • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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