Natural Instability of Equilibrium Prices

Dmitry Levando () and Maxim Sakharov
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Dmitry Levando: National Research University Higher School of Economics, Moscow, Russia
Maxim Sakharov: Bauman Mstu, Moscow, Russia

No 2018:01, Working Papers from Department of Economics, University of Venice "Ca' Foscari"

Abstract: We develop a theory of market fluctuations caused by strategic trade with complete information and without outside shocks. The constructed general equilibrium duopoly is a strategic market game with infinite strategies and multiple mixed strategies equilibria. First order conditions (FOC) of the game are the ill-posed problems (Hadamard, 1909), but every equilibrium mixed strategy can be only approximated. This imposes restrictions on convergence of common beliefs of players about actions of each other, existence of rational expectations and a price discovery property of the market, although the market is informationally efficient (Fama, 1970). We suggest a modification of Tikhonov regularization to construct pseudo-solutions. All endogenous variables of the model are exposed to unremovable instabilities, ‘natural instabilities', specific to parameters of a chosen approximation. Our result is also related to existence of common knowledge, sun-spot equilibrium, and noise trade.

Keywords: Strategic market games; ill-posed problems; common knowledge; rational expectations; efficient market; price fluctuations (search for similar items in EconPapers)
JEL-codes: C61 C68 C72 D59 E31 E32 G14 (search for similar items in EconPapers)
Pages: 39 pages
Date: 2018
New Economics Papers: this item is included in nep-gth, nep-mac and nep-mic
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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