More hedging instruments may destabilize markets

William Brock, Cars Hommes and Florian Wagener

Journal of Economic Dynamics and Control, 2009, vol. 33, issue 11, 1912-1928

Abstract: This paper formalizes the idea that more hedging instruments may destabilize markets when traders have heterogeneous expectations and adapt their behavior according to performance-based reinforcement learning. In a simple asset pricing model with heterogeneous beliefs the introduction of additional Arrow securities may destabilize markets, and thus increase price volatility, and at the same time decrease average welfare. We also investigate whether a fully rational agent can employ additional hedging instruments to stabilize markets. It turns out that the answer depends on the composition of the population of non-rational traders and the information gathering costs for rationality.

Keywords: Financial; innovation; Asset; pricing; Hedging; Reinforcement; learning; Bifurcations (search for similar items in EconPapers)
Date: 2009
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Citations: View citations in EconPapers (98)

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Related works:
Working Paper: More hedging instruments may destabilize markets (2008)
Working Paper: More Hedging Instruments may destablize Markets (2008)
Working Paper: More hedging instruments may destabilize markets (2006)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:33:y:2009:i:11:p:1912-1928

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