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The Virtues and Vices of Equilibrium and the Future of Financial Economics

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  • J. Doyne Farmer
  • John Geanakoplos

Abstract

The use of equilibrium models in economics springs from the desire for parsimonious models of economic phenomena that take human reasoning into account. This approach has been the cornerstone of modern economic theory. We explain why this is so, extolling the virtues of equilibrium theory; then we present a critique and describe why this approach is inherently limited, and why economics needs to move in new directions if it is to continue to make progress. We stress that this shouldn't be a question of dogma, but should be resolved empirically. There are situations where equilibrium models provide useful predictions and there are situations where they can never provide useful predictions. There are also many situations where the jury is still out, i.e., where so far they fail to provide a good description of the world, but where proper extensions might change this. Our goal is to convince the skeptics that equilibrium models can be useful, but also to make traditional economists more aware of the limitations of equilibrium models. We sketch some alternative approaches and discuss why they should play an important role in future research in economics.
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  • J. Doyne Farmer & John Geanakoplos, 2008. "The Virtues and Vices of Equilibrium and the Future of Financial Economics," Levine's Working Paper Archive 122247000000002067, David K. Levine.
  • Handle: RePEc:cla:levarc:122247000000002067
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    • A10 - General Economics and Teaching - - General Economics - - - General
    • A12 - General Economics and Teaching - - General Economics - - - Relation of Economics to Other Disciplines
    • B0 - Schools of Economic Thought and Methodology - - General
    • B40 - Schools of Economic Thought and Methodology - - Economic Methodology - - - General
    • B50 - Schools of Economic Thought and Methodology - - Current Heterodox Approaches - - - General
    • C69 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Other
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    • D5 - Microeconomics - - General Equilibrium and Disequilibrium
    • D1 - Microeconomics - - Household Behavior
    • G1 - Financial Economics - - General Financial Markets
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
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