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The Toll of Subrational Trading in an Agent Based Economy

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  • Paolo Pellizzari

Abstract

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.

Suggested Citation

  • Paolo Pellizzari, 2008. "The Toll of Subrational Trading in an Agent Based Economy," Research Paper Series 217, Quantitative Finance Research Centre, University of Technology, Sydney.
  • Handle: RePEc:uts:rpaper:217
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    File URL: https://www.uts.edu.au/sites/default/files/qfr-archive-02/QFR-rp217.pdf
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    References listed on IDEAS

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    1. LiCalzi, Marco & Pellizzari, Paolo, 2007. "Simple market protocols for efficient risk sharing," Journal of Economic Dynamics and Control, Elsevier, vol. 31(11), pages 3568-3590, November.
    2. 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.
    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, Richard H. & Huang, Weihong, 1990. "Bulls, bears and market sheep," Journal of Economic Behavior & Organization, Elsevier, vol. 14(3), pages 299-329, December.
    5. 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.
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    Keywords

    risk sharing; boundedly rationality; cost of subrational trading; agent-based markets;

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