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Endogenous equilibria in liquid markets with frictions and boundedly rational agents

  • Paolo Dai Pra

    ()

    (Department of Pure and Applied Mathematics, Università di Padova)

  • Fulvio Fontini

    ()

    ("M. Fanno" Department of Economics and Management, Università di Padova)

  • Elena Sartori

    ()

    (Department of Management, Università Ca' Foscari Venezia)

  • Marco Tolotti

    ()

    (Department of Management, Università Ca' Foscari Venezia)

In this paper we propose a simple binary mean field game, where N agents may decide whether to trade or not a share of a risky asset in a liquid market. The asset's returns are endogenously determined taking into account demand and transaction costs. Agents' utility depends on the aggregate demand, which is determined by all agents' observed and forecasted actions. Agents are boundedly rational in the sense that they can go wrong choosing their optimal strategy. The explicit dependence on past actions generates endogenous dynamics of the system. We, firstly, study under a rather general setting (risk attitudes, pricing rules and noises) the aggregate demand for the asset, the emerging returns and the structure of the equilibria of the asymptotic game. It is shown that multiple Nash equilibria may arise. Stability conditions are characterized, in particular boom and crash cycles are detected. Then we precisely analyze properties of equilibria under significant examples, performing comparative statics exercises and showing the stabilizing property of exogenous transaction costs.

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File Function: First version, 2011
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Paper provided by Department of Management, Università Ca' Foscari Venezia in its series Working Papers with number 7.

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Length: 35 pages
Date of creation: Aug 2011
Date of revision:
Handle: RePEc:vnm:wpdman:7
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  1. Paolo Dai Pra & Wolfgang J. Runggaldier & Elena Sartori & Marco Tolotti, 2007. "Large portfolio losses: A dynamic contagion model," Papers 0704.1348, arXiv.org, revised Mar 2009.
  2. Roger Guesnerie, 2001. "Assessing Rational Expectations: Sunspot Multiplicity and Economic Fluctuations," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262072076, June.
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  12. Alessandro Citanna & John Donaldson & Herakles Polemarchakis & Paolo Siconolfi & Stephen Spear, 2004. "General equilibrium, incomplete markets and sunspots: A symposium in honor of David Cass," Economic Theory, Springer, vol. 24(3), pages 465-468, October.
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  16. Shleifer, Andrei, 2000. "Inefficient Markets: An Introduction to Behavioral Finance," OUP Catalogue, Oxford University Press, number 9780198292272, March.
  17. Chang, Sheng-Kai, 2007. "A simple asset pricing model with social interactions and heterogeneous beliefs," Journal of Economic Dynamics and Control, Elsevier, vol. 31(4), pages 1300-1325, April.
  18. Hommes, Cars H., 2006. "Heterogeneous Agent Models in Economics and Finance," Handbook of Computational Economics, in: Leigh Tesfatsion & Kenneth L. Judd (ed.), Handbook of Computational Economics, edition 1, volume 2, chapter 23, pages 1109-1186 Elsevier.
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