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The Toll of Subrational Trading in an Agent Based Economy

Paolo Pellizzari

No 217, Research Paper Series from Quantitative Finance Research Centre, University of Technology, Sydney

Abstract: In an agent-based exchange economy, we measure the loss of wealth for rational agents due to the presence of varying proportions of subrational (boundedly rational) traders that do not know all the needed parameters. We consider two departures from rationality: M-traders use private, stochastic and unbiased signals to build an estimate of the value of the risky asset; chartists only use the last observed price. The exchange takes place using a realistic continuous double auction. We show by numerical simulations that M-traders’ subrational behavior does not reduce the wealth of the rational agents. On the contrary, a sizable fraction of chartists can lead to mispricing of the risky asset and to a reduction of the wealth share of the rational traders. Moreover, as chartists perceive a higher wealth than the others, due to wrong estimates of the fundamental value, their fraction in the market may not dissolve in the long run.

Keywords: risk sharing; boundedly rationality; cost of subrational trading; agent-based markets (search for similar items in EconPapers)
Pages: 19 pages
Date: 2008-03-01
New Economics Papers: this item is included in nep-cbe, nep-cmp, nep-dge, nep-mst and nep-upt
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