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http://ssrn.com/abstract=933043
 
 

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More Hedging Instruments May Destabilize Markets


William A. Brock


University of Wisconsin, Madison - Department of Economics ; University of Missouri at Columbia - Department of Economics

C. H. Hommes


University of Amsterdam; CeNDEF; Tinbergen Institute

Florian O. Wagener


University of Amsterdam - Center for Nonlinear Dynamics in Economics and Finance (CeNDEF) - Department of Quantitative Economics; Tinbergen Institute

April 2008

TI Discussion Paper No. 06-080/1

Abstract:     
This paper formalizes the idea that more hedging instruments may destabilize markets when traders are heterogeneous and adapt their behavior according to experience based reinforcement learning. We investigate three different economic settings, a simple mean-variance asset pricing model, a general equilibrium two-period overlapping generations model with heterogeneous expectations and a noisy rational expectations asset pricing model with heterogeneous information signals. In each setting the introduction of additional Arrow securities can destabilize the market, causing a bifurcation of the steady state to multiple steady states, periodic orbits or even chaotic fluctuations.

Number of Pages in PDF File: 34

Keywords: Asset pricing, hedging, reinforcement learning, nonlinear dynamics, bifurcations

JEL Classification: D52, D53, D83, D84, G32

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Date posted: September 28, 2006 ; Last revised: May 27, 2008

Suggested Citation

Brock, William A. and Hommes, C. H. and Wagener, Florian O., More Hedging Instruments May Destabilize Markets (April 2008). Available at SSRN: http://ssrn.com/abstract=933043 or http://dx.doi.org/10.2139/ssrn.933043

Contact Information

William A. Brock
University of Wisconsin, Madison - Department of Economics ( email )
1180 Observatory Drive
Madison, WI 53706
United States
608-263-6655 (Phone)
608-263-3876 (Fax)
University of Missouri at Columbia - Department of Economics ( email )
118 Professional Building
Columbia, MO 65211
United States
C. H. Hommes (Contact Author)
University of Amsterdam ( email )
Roetersstraat 11
Amsterdam, 1018WB
Netherlands
CeNDEF ( email )
Roetersstraat 11
Amsterdam, NL-1018WB
Netherlands
HOME PAGE: http://www1.fee.uva.nl/cendef/
Tinbergen Institute ( email )
Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands
Florian O. Wagener
University of Amsterdam - Center for Nonlinear Dynamics in Economics and Finance (CeNDEF) - Department of Quantitative Economics ( email )
Roetersstraat 11
Amsterdam, 1018 WB
Netherlands
Tinbergen Institute ( email )
Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands
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