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Financial Markets Can Be at Sub-Optimal Equilibria

Author

Listed:
  • Shareen Joshi
  • Jeffrey Parker
  • Mark A. Bedau

Abstract

We use game theory and the Santa Fe Artificial Stock Market, an agent-based model of an evolving stock market, to study the properties of strategic Nash equilibria in financial markets. We discover two things: there is a unique strategic equilibrium in the market, and this equilibrium in sub-optimal since traders' earnings are not maximized and the market is inefficient. The inevitability of this strategic equilibrium is due to an analogue of the prisoner's dilemma; the optimal global state is unstable because each individual has too much incentive to ``defect'' and use forecasting rules that pull the market into the sub-optimal equilibrium. Submitted to Computational Economics (special issue on Evolutionary Processes in Economics).

Suggested Citation

  • Shareen Joshi & Jeffrey Parker & Mark A. Bedau, 1999. "Financial Markets Can Be at Sub-Optimal Equilibria," Working Papers 99-03-023, Santa Fe Institute.
    • Handle: RePEc:wop:safiwp:99-03-023
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    Cited by:

    1. Konrad RICHTER, 2010. "Revenue Equivalence Revisited: Bounded Rationality in Auctions," EcoMod2004 330600118, EcoMod.

    More about this item

    Keywords

    Finance; efficiency; Nash equilibrium; game theory; agent-based models; Prisoner's dilemma;
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