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The Toll of Subrational Trading in an Agent Based Economy

  • Paolo Pellizzari

In an agent-based exchange economy, we measure the loss of wealth for rational agents due to the presence of varying proportions of subrational (boundedly rational) traders that do not know all the needed parameters. We consider two departures from rationality: M-traders use private, stochastic and unbiased signals to build an estimate of the value of the risky asset; chartists only use the last observed price. The exchange takes place using a realistic continuous double auction. We show by numerical simulations that M-traders’ subrational behavior does not reduce the wealth of the rational agents. On the contrary, a sizable fraction of chartists can lead to mispricing of the risky asset and to a reduction of the wealth share of the rational traders. Moreover, as chartists perceive a higher wealth than the others, due to wrong estimates of the fundamental value, their fraction in the market may not dissolve in the long run.

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File URL: http://www.business.uts.edu.au/qfrc/research/research_papers/rp217.pdf
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Paper provided by Quantitative Finance Research Centre, University of Technology, Sydney in its series Research Paper Series with number 217.

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Length: 19
Date of creation: 01 Mar 2008
Date of revision:
Handle: RePEc:uts:rpaper:217
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  1. Marco LiCalzi & Paolo Pellizzari, 2005. "Simple market protocols for efficient risk sharing," Finance 0504019, EconWPA.
  2. Grinblatt, Mark & Titman, Sheridan & Wermers, Russ, 1995. "Momentum Investment Strategies, Portfolio Performance, and Herding: A Study of Mutual Fund Behavior," American Economic Review, American Economic Association, vol. 85(5), pages 1088-1105, December.
  3. Chan, Louis K C & Jegadeesh, Narasimhan & Lakonishok, Josef, 1996. " Momentum Strategies," Journal of Finance, American Finance Association, vol. 51(5), pages 1681-1713, December.
  4. Day, R. & Huang, W., 1988. "Bulls, Bears And Market Sheep," Papers m8822, Southern California - Department of Economics.
  5. C. Chiarella & X-Z. He, 2001. "Asset price and wealth dynamics under heterogeneous expectations," Quantitative Finance, Taylor & Francis Journals, vol. 1(5), pages 509-526.
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