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More hedging instruments may destabilize markets

  • Florian Wagener
  • Cars Hommes
  • William Brock

This discussion paper resulted in a publication in the 'Journal of Economic Dynamics & Control' . Volume 33(11), pp. 1912-1928. 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 Warwick Business School, Finance Group in its series Working Papers with number wp06-11.

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Date of creation: 2006
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Handle: RePEc:wbs:wpaper:wp06-11
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