Learning and Adaptation as a Source of Market Failure

36 Pages Posted: 31 Aug 2013

See all articles by David Goldbaum

David Goldbaum

University of Technology Sydney

Date Written: August 29, 2013

Abstract

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

Goldbaum, David, Learning and Adaptation as a Source of Market Failure (August 29, 2013). Available at SSRN: https://ssrn.com/abstract=2318172 or http://dx.doi.org/10.2139/ssrn.2318172

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