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Endogenous equilibria in liquid markets with frictions and boundedly rational agents

Author

Listed:
  • Paolo Dai Pra

    (Department of Pure and Applied Mathematics, Università di Padova)

  • Fulvio Fontini

    ("M. Fanno" Department of Economics and Management, Università di Padova)

  • Elena Sartori

    (Department of Management, Università Ca' Foscari Venezia)

  • Marco Tolotti

    (Department of Management, Università Ca' Foscari Venezia)

Abstract

In this paper we propose a simple binary mean field game, where N agents may decide whether to trade or not a share of a risky asset in a liquid market. The asset's returns are endogenously determined taking into account demand and transaction costs. Agents' utility depends on the aggregate demand, which is determined by all agents' observed and forecasted actions. Agents are boundedly rational in the sense that they can go wrong choosing their optimal strategy. The explicit dependence on past actions generates endogenous dynamics of the system. We, firstly, study under a rather general setting (risk attitudes, pricing rules and noises) the aggregate demand for the asset, the emerging returns and the structure of the equilibria of the asymptotic game. It is shown that multiple Nash equilibria may arise. Stability conditions are characterized, in particular boom and crash cycles are detected. Then we precisely analyze properties of equilibria under significant examples, performing comparative statics exercises and showing the stabilizing property of exogenous transaction costs.

Suggested Citation

  • Paolo Dai Pra & Fulvio Fontini & Elena Sartori & Marco Tolotti, 2011. "Endogenous equilibria in liquid markets with frictions and boundedly rational agents," Working Papers 7, Venice School of Management - Department of Management, Università Ca' Foscari Venezia.
    • Handle: RePEc:vnm:wpdman:7
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    References listed on IDEAS

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    More about this item

    Keywords

    Endogenous dynamics; Nash equilibria; Bounded rationality; Transaction costs; Mean field games; Random utility;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • C62 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Existence and Stability Conditions of Equilibrium
    • C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games

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