The Virtues and Vices of Equilibrium and the Future of Financial Economics

J. Farmer and John Geanakoplos ()
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John Geanakoplos: Cowles Foundation, Yale University, https://economics.yale.edu/people/faculty/john-geanakoplos

No 1647, Cowles Foundation Discussion Papers from Cowles Foundation for Research in Economics, Yale University

Abstract: The use of equilibrium models in economics springs from the desire for parsimonious models of economic phenomena that take human reasoning into account. This approach has been the cornerstone of modern economic theory. We explain why this is so, extolling the virtues of equilibrium theory; then we present a critique and describe why this approach is inherently limited, and why economics needs to move in new directions if it is to continue to make progress. We stress that this shouldn’t be a question of dogma, but should be resolved empirically. There are situations where equilibrium models provide useful predictions and there are situations where they can never provide useful predictions. There are also many situations where the jury is still out, i.e., where so far they fail to provide a good description of the world, but where proper extensions might change this. Our goal is to convince the skeptics that equilibrium models can be useful, but also to make traditional economists more aware of the limitations of equilibrium models. We sketch some alternative approaches and discuss why they should play an important role in future research in economics.

Keywords: Equilibrium; Rational expectations; Efficiency; Arbitrage; Bounded rationality; Power laws; Disequilibrium; Zero intelligence; Market ecology; Agent based modeling (search for similar items in EconPapers)
JEL-codes: A10 A12 B0 B40 B50 C69 C9 D1 D5 G1 G10 G11 G12 G13 G14 (search for similar items in EconPapers)
Pages: 68 pages
Date: 2008-03
New Economics Papers: this item is included in nep-bec, nep-cba and nep-cmp
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (17)

Published in Complexity (Jan/Feb 2009), 14(3): 11-38

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Working Paper: The virtues and vices of equilibrium and the future of financial economics (2008)
Working Paper: The Virtues and Vices of Equilibrium and the Future of Financial Economics (2008)
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