Financial Markets can be at Sub-Optimal Equilibria

Authors:
Shareen Joshi;Jeffrey Parker;Mark A. Bedau
Affiliations:
Reed College, 3203 SE Woodstock Blvd., Portland OR 97202, U.S.A. E-mail: shareen@santafe.edu/ Santa Fe Institute, 1399 Hyde Park Rd., Santa Fe NM 87501, U.S.A.;Reed College, 3203 SE Woodstock Blvd., Portland OR 97202, U.S.A. E-mail: jeffrey.parker@reed.edu/;Santa Fe Institute, 1399 Hyde Park Rd., Santa Fe NM 87501, U.S.A. E-mail: mab.reed@edu
Venue:
Computational Economics - Special issue: Evolutionary processes in economics
Year:
2002

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Abstract

We use game theory and Santa Fe Artificial Stock Market, anagent-based model of an evolving stock market, to study theoptimal frequency for traders to revise their market forecastingrules. We discover two things: There is a unique strategic Nashequilibrium in the game of choosing forecast revision rates, andthis equilibrium is sub-optimal in the sense that traders'earnings are not maximized an the market is inefficient. Thisstrategic equilibrium is due to an analogue of the prisoner'sdilemma; the optimal global state is unstable because eachtrader has too much incentive to `defect' and use forecastingrules that pull the market into thesub-optimal equilibrium.