Learning and Adaptation as a Source of Market Failure
36 Pages Posted: 31 Aug 2013
Date Written: August 29, 2013
In the developed model, without knowing the trading strategies of the other traders in a financial market, traders cannot derive a rational expectations equilibrium. In a dynamic setting, market participants employ learning and adaptation to develop trading strategies to accommodate for this information deficiency. Model-consistent use of market-based information generally improves price performance. It can also produce episodes of extreme sudden mispricing despite model generated historical support for its use. Simulations examine the impact of information constraints and bounded rationality on general price efficiency and sudden market mispricing.
Keywords: Heterogeneous Agents, Efficient Markets, Learning, Dynamics, Computational Economics, Market Failure
JEL Classification: G14, C62, D82
Suggested Citation: Suggested Citation