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Convex Incentives in Financial Markets: an Agent-Based Analysis

Annalisa Fabretti (), Tommy Gärling (), Stefano Herzel () and Martin Holmen
Additional contact information
Tommy Gärling: University of Gothenburg
Stefano Herzel: DEF and CEIS, University of Rome Tor Vergata, http://www.ceistorvergata.it

No 337, CEIS Research Paper from Tor Vergata University, CEIS

Abstract: This paper uses agent-based simulation to analyze how financial markets are affected by market participants with convex incentives, e.g. option-like compensation. We document that convex incentives are associated with (i) higher prices, (ii) larger variations of prices, and (iii) larger bid-ask spreads. We conclude that convex incentives may lead to decreased stability of financial markets. Our analysis suggests that the decreased stability is driven by the fact that convex incentives pushes agents towards more extreme decisions. Furthermore, while risk preferences affect agent behavior if they have linear incentives, the effect of risk preferences vanishes with convex incentives.

Keywords: incentives; market instability; agent-based simulations. (search for similar items in EconPapers)
JEL-codes: G10 D40 D53 (search for similar items in EconPapers)
Pages: 32 pages
Date: 2015-04-08, Revised 2015-04-08
New Economics Papers: this item is included in nep-cfn, nep-cmp, nep-cta, nep-hrm and nep-ore
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Journal Article: Convex incentives in financial markets: an agent-based analysis (2017) Downloads
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