2011/11 | LEM Working Paper Series | |
Selection in asset market: the good, the bad, and the unknown |
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Giulio Bottazzi and Pietro Dindo |
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Keywords | ||
Market Selection; Evolutionary Finance; Informational Efficiency; Asset Pricing; CRRA preferences
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JEL Classifications: D50, D80, G11, G12 | ||
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Abstract | ||
In this paper, we use a series of simple examples to illustrate how
wealth-driven selection works in a market for Arrow securities. Our
analysis delivers both a good and a bad message. The good message is
that, when traders invest constant fractions of their wealth in each
asset and have equal consumption rates, markets are informationally
effcient: the best informed agent is rewarded and asset prices
eventually reflect this information. However, and this is the bad
message, when asset demands are not constant fractions of wealth but
dependent upon prices, markets might behave sub-optimally. In this
case, asymptotic prices depend on preferences and beliefs of the whole
ecology of traders and do not, in general, reflect the best available
information. We show that the key difference between the two cases lies
in the local, i.e. price dependent, versus global nature of
wealth-driven selection.
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