Financial Markets Can Be at Sub-Optimal Equilibria

Shareen Joshi, Jeffrey Parker and Mark A. Bedau

Working Papers from Santa Fe Institute

Abstract: We use game theory and the Santa Fe Artificial Stock Market, an agent-based model of an evolving stock market, to study the properties of strategic Nash equilibria in financial markets. We discover two things: there is a unique strategic equilibrium in the market, and this equilibrium in sub-optimal since traders' earnings are not maximized and the market is inefficient. The inevitability of this strategic equilibrium is due to an analogue of the prisoner's dilemma; the optimal global state is unstable because each individual has too much incentive to ``defect'' and use forecasting rules that pull the market into the sub-optimal equilibrium.

Submitted to Computational Economics (special issue on Evolutionary Processes in Economics).

Keywords: Finance; efficiency; Nash equilibrium; game theory; agent-based models; Prisoner's dilemma (search for similar items in EconPapers)
Date: 1999-03
New Economics Papers: this item is included in nep-cmp, nep-fin and nep-mic
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:wop:safiwp:99-03-023

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