economics: agents, information, & markets

Brought to you by:

Carl Plat

Economists are still discovering how markets work. This might be little known to the thousands of market participants who trade in the markets each day. The standard accepted theory is that markets are efficient in that all relevant information is reflected in market prices. As a consequence, if markets contain all information available, any additional research effort made returns only enough to compensate the extra effort used to gather the additional information. And usually it is added that miss-pricings in the market, if they exist, last for only a short time so you must be quick to take advantage of them.

A more satisfying explanation of the question of "how markets work" comes from three areas of economics: Theories of Agent Based Market Dynamics, Theories of Information in Prices, and Theories of Trading Strategies & Rational Speculation. The following lists & links will introduce you to some of the people and places where new market theories are being developed. In these theories, markets take on strange behaviors where markets outcomes are described as emerging, evolving, or self-organizing. And where market participants are described as rational, nearly rational, or robots. Market participants may compete, cooperate, or follow some form of adaptive strategy. Together, markets and market participants interact in complex, sometimes chaotic, ways where the passage of time and feedback effects affect outcomes. After spending time with these theories, markets will never look the same to you.

What does all this have to do with Derivatives? Derivatives are valued based on certain theories of how agents make decisions. In the case of mortgage derivatives, the common practice is to use simulations to value the derivative. These are often very simple simulations, and use very little of what has been learned from simulations of large numbers of interacting agents, simulations of markets, or simulation of market economies. Eventually insights from this research will reach the modeling of derivatives. I am always looking for insight into my own models with the help of this research.

People & Places

Dan Friedman and Dan Friedman's Papers and Axel Leijonhufvud and J. Doyne Farmer and Larry Blume and Leigh Tesfatsi and Tim Cason's Home Page and Tim Cason's Papers and Joseph Stiglitz and Peter Kriz and W. Brian Arthur and Yin-Wong Cheung

Agent Based Comput Economics and Economic Science Association (ESA) and Kardi Teknomo's list of Simulation Journals and Leigh Tesfatsion's List of Individuals Engaged in ACE Research and Mike Wooldrige's Agent Related Pages and MultiAgen Site with List of Paperst and Landscape Dynamics (Friedman and Abraham of the Visual Math Institute) and The Santa Fe Institute and Game Theory and UC Santa Cruz Experimental Laboratory: LEEPS and Univeristy of Trento Experimental Laboratory: CEEL and Computational Economics and Efficient Market Hypothesis References.

Books on Informational Economics

Jack Hirshleifer and John G. Riley, The Analytics of Uncertainty and Information

Sanford Grossman, The Informational Role of Prices

Roger E. A. Farmer, Macroeconomics of Self-fulfilling Prophecies - 2nd Edition

Daniel Friedman and Shyam Sunder, Experimental Methods : A Primer for Economists

Daniel Friedman and John Rust, The Double Auction Market: Institutions, Theories, and Evidence (Santa Fe Institute Studies in the Sciences of Complexity Proceedings)

Alessandra Cassar and Daniel Friedman, Economics Lab: An Intensive Course in Experimental Economics (Routledge Advances in Experimental and Computable Economics)

Jean-Jacques Laffont, The Economics of Uncertainty and Information

Papers by me:

"Introduction to the Market Microstructure Literature Applied to the Foreign Exchange Market" Dissertation UC Santa Cruz, 1995. (Pdf)

"Noisy Rational Expectations with Stochastic Fundamentals" Dissertation UC Santa Cruz, 1995. (Pdf)

"A Double Auction Market with Signals of Varying Precision" Dissertation UC Santa Cruz, 1995 (Revised 1997) (Pdf)

"A Mixing Model with Zero Intelligence Traders" Dissertation UC Santa Cruz, 1995. (Pdf)

"Troubled Assets: Elements of the Mortgage Crisis" UCSC Economics Seminar Presentation, October 2008. (Pdf)

Papers where I contributed as a research assistant:

Timothy Cason and Daniel Friedman, "Price Formation in Single Call Markets" Econometrica, 65(2), 1997. (Cason)

Timothy Cason and Daniel Friedman, "Price Formation and Exchange in Thin Markets: A Laboratory Comparison of Institutions", Published in E. de Antoni, P. Howitt and A. Leijonhufvud (eds.), Money, Markets and Method: Essays in Honour of Robert W. Clower, 1999. (Cason)

Timothy Cason and Daniel Friedman, "Learning in a Laboratory Market with Random Supply and Demand" Experimental Economics, 2(1), 1999. (Cason)

Timothy Cason and Daniel Friedman, "Price Formation in Double Auction Markets" Journal of Economic Dynamics and Control, 8, 1996.

Yin-Wong Cheung and Daniel Friedman, "Individual Learning in Normal Form Games: Some Laboratory Results" Games and Economic Behavior, 19, 1997.

Daniel Friedman, "Equilibrium in Evolutionary Games: Some Experimental Results" The Economic Journal, 106, 1996.

Daniel Friedman, "On Evolution and Learning in Games" Cuadernos Economicos de ICE, 54(2), 1993, 171-196.

Changhua Sun Rich and Daniel Friedman, "The Matching Market Institution: A Laboratory Investigation" American Economic Review, 88(5), 1998, 1311-1322.

Papers with citations of my papers:

Daniel Friedman, "Market Theories Evolve, And so Do Markets" Journal of Economic Behavior & Organization, 2007.

Todd Feldman and Daniel Friedman, "Robots and Market Crashes: A Laboratory Study" Available at SSRN, October 2008. (Pdf)

Todd Feldman and Daniel Friedman, "Human and Artificial Agents in a Crash-Prone Financial Market" Computational Economics, 2010. (Pdf)

Chi Xu and Jia Na, "Imitation of Real Market Dynamics by Construction of Multi-agent Based Evolutionary Artificial Market" 2011 10th IEEE/ACIS International Conference on Computer and InformatIon Science, 2011. (Pdf)

More on markets:

Lana Friesen and Lata Gangadharan, "Environmental Markets: What do we learn from the lab?" Journal of Economic Surveys, 2013. (Pdf)

David Goldbaum, "On the Possibility of Informationally Efficient Markets" Department of Economics, Rutgers University, 2004. (Pdf)