More Hedging Instruments May Destabilize Markets

TI Discussion Paper No. 06-080/1

34 Pages Posted: 28 Sep 2006 Last revised: 27 May 2008

See all articles by William A. Brock

William A. Brock

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

Cars H. Hommes

Government of Canada - Bank of Canada; CeNDEF, Amsterdam School of Economics, University of Amsterdam; Tinbergen Institute

Florian Wagener

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

Date Written: April 2008

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.

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

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

Suggested Citation

Brock, William A. and Hommes, Cars H. and Wagener, Florian O.O., More Hedging Instruments May Destabilize Markets (April 2008). TI Discussion Paper No. 06-080/1, Available at SSRN: https://ssrn.com/abstract=933043 or http://dx.doi.org/10.2139/ssrn.933043

William A. Brock

University of Wisconsin, Madison - Department of Economics ( email )

1180 Observatory Drive
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University of Missouri at Columbia - Department of Economics ( email )

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Columbia, MO 65211
United States

Cars H. Hommes (Contact Author)

Government of Canada - Bank of Canada ( email )

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Ontario, Ottawa K1A 0G9
Canada

CeNDEF, Amsterdam School of Economics, University of Amsterdam ( email )

Roetersstraat 11
Amsterdam, NL-1018WB
Netherlands

HOME PAGE: http://https://www.uva.nl/en/profile/h/o/c.h.hommes/c.h.hommes.html

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

Florian O.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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