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More Hedging Instruments may destablize Markets

Author

Listed:
  • William Brock

    (University of Wisconsin, USA)

  • Cars Hommes

    (Universiteit van Amsterdam)

  • Florian Wagener

    (Universiteit van Amsterdam)

Abstract
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.

Suggested Citation

  • William Brock & Cars Hommes & Florian Wagener, 2006. "More Hedging Instruments may destablize Markets," Tinbergen Institute Discussion Papers 06-080/1, Tinbergen Institute, revised 30 Apr 2008.
    • Handle: RePEc:tin:wpaper:20060080
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    More about this item

    Keywords

    Asset pricing; hedging; reinforcement learning; nonlinear dynamics; bifurcations;
    All these keywords.

    JEL classification:

    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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