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Deviations from the Nash equilibrium and emergence of tacit collusion in a two-player optimal execution game with reinforcement learning

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  • Fabrizio Lillo
  • Andrea Macr`i

Abstract

The use of reinforcement learning algorithms in financial trading is becoming increasingly prevalent. However, the autonomous nature of these algorithms can lead to unexpected outcomes that deviate from traditional game-theoretical predictions and may even destabilize markets. In this study, we examine a scenario in which two autonomous agents, modeled with Double Deep Q-Learning, learn to liquidate the same asset optimally in the presence of market impact, using the Almgren-Chriss (2000) framework. Our results show that the strategies learned by the agents deviate significantly from the Nash equilibrium of the corresponding market impact game. Notably, the learned strategies exhibit tacit collusion, closely aligning with the Pareto-optimal solution. We further explore how different levels of market volatility influence the agents' performance and the equilibria they discover, including scenarios where volatility differs between the training and testing phases.

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  • Fabrizio Lillo & Andrea Macr`i, 2024. "Deviations from the Nash equilibrium and emergence of tacit collusion in a two-player optimal execution game with reinforcement learning," Papers 2408.11773, arXiv.org.
    • Handle: RePEc:arx:papers:2408.11773
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    References listed on IDEAS

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    1. Alexander Schied & Tao Zhang, 2019. "A Market Impact Game Under Transient Price Impact," Mathematics of Operations Research, INFORMS, vol. 44(1), pages 102-121, February.
    2. Matthias Hettich, 2021. "Algorithmic Collusion: Insights from Deep Learning," CQE Working Papers 9421, Center for Quantitative Economics (CQE), University of Muenster.
    3. Alexander Schied & Tao Zhang, 2017. "A State-Constrained Differential Game Arising In Optimal Portfolio Liquidation," Mathematical Finance, Wiley Blackwell, vol. 27(3), pages 779-802, July.
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