uncertainty and risk in financial markets this paper considers a general equilibrium model in which the distinction between uncertainty and risk is formalized by assuming agents have incomplete preferences over statecontingent consumption bundles as in bewley 1986 without completeness individual decision making depends on a set of probability distributions over the state space a bundle is preferred to another if and only if it has larger expected utility for all probabilities in this set when preferences are complete this set is a singleton and the model reduces to standard expected utility in this setting we characterize pareto optima and equilibria and show that the presence of uncertainty generates robust indeterminacies in equilibrium prices and allocations for any specification of initial endowments we derive comparative statics results linking the degree of uncertainty with changes in equilibria despite the presence of robust indeterminacies we show that equilibrium prices and allocations vary continuously with underlying fundamentals equilibria in a standard risk economy are thus robust to adding small degrees of uncertainty finally we give conditions under which some assets are not traded due to uncertainty aversion

altruistic versus egoistic behavior in a public good game this paper analyzes an evolutionary version of the public good game in which boundedly rational agents can use imitation and best reply decision rules several possibilities for both decision rules to be present in the population are considered i show that altruistic behavior might survive if switching between the decision rules occurs less often than the probabilities of errors in choosing a strategy and if local neighborhoods are not too small or too large

rational behavior and economic theory abstract nowadays it seems almost universally presumed that the fundamental characteristic of homo oeconomicus is his rationality we analyze the role played by the concept of rationality in economic theory and demonstrate that it is necessarily constrained to be an essentially contentless notion we show that the main body of economic theory is firmly grounded and that some contrasting approaches to rationality although leading to heated debates and vivid confusion have no fundamental significance for economics with a refereshed view on the essence of economics we argue that the principles of economic theory form an essential methodological guide for the emergent line of research based on the use of so called evolutive models

minimum cost portfolio insurance abstract minimum cost portfolio insurance is an investment strategy that enables an investor to avoid losses while still capturing gains of a payoff of a portfolio at minimum cost if derivative markets are complete then holding a put option in conjunction with the reference portfolio provides minimum cost insurance at arbitrary arbitrage free security prices we derive a characterization of incomplete derivative markets in which the minimum cost portfolio insurance is independent of arbitrage free security prices our characterization relies on the theory of lattice subspaces we establish that a necessary and sufficient condition for price independent minimum cost portfolio insurance is that the asset span is a lattice subspace of the space of contingent claims if the asset span is a lattice subspace then the minimum cost portfolio insurance can be easily calculated as a portfolio that replicates the targeted payoff in a subset of states which is the same for every reference portfolio

a comparison of var and cvar constraints on portfolio selection with the mean variance model in this paper we analyze the portfolio selection implications arising from imposing a value at risk var constraint on the mean variance model and compare them with those arising from the imposition of a conditional value at risk cvar constraint we show that for a given confidence level a cvar constraint is tighter than a var constraint if the cvar and var bounds coincide consequently a cvar constraint is more effective than a var constraint as a tool to control slightly risk averse agents but in the absence of a risk free security has a perverse effect in that it is more likely to force highly risk averse agents to select portfolios with larger standard deviations however when the cvar bound is appropriately larger than the var bound or when a risk free security is present a cvar constraint dominates a var constraint as a risk management tool

strategies and evolution in the minority game a multi round strategy experiment abstract minority games are a stylized description of strategic situations with both coordination and competition these games are widely studied using either simulations or laboratory experiments simulations can show the dynamics of aggregate behavior but the results of such simulations depend on the type of strategies used so far experiments provided little guidance on the type of strategies people use because the set of possible strategies is very large we therefore use a multi round strategy method experiment to directly elicit people s strategies between rounds participants can adjust their strategy and test the performance of possible new strategies against strategies from the previous round strategies gathered in the experiment are subjected to an evolutionary competition the strategies people use are very heterogeneous although aggregate outcomes resemble the symmetric nash equilibrium the strategies that survive evolutionary competition achieve much higher levels of coordination

reinforcement learning in the el farol model abstract the paper applies the approach of reinforcement learning to arthur s american economic review 84 1994a 406 el farol problem where repeatedly a population of agents decides to go to a bar or stay home and going is enjoyable if and only if the bar is not crowded the numerical simulations show that the learning process is fairly efficient in that attendances tend to fluctuate around the bar s capacity on the other hand the shape of the long run equilibrium frequency distribution is usually quite distinct from the nash equilibrium solutions and furthermore rather sensitive to some of the model s specification details

optimal fiscal policy in a business cycle model this paper develops the quantitative implications of optimal fiscal policy in a business cycle model in a stationary equilibrium the ex ante tax rate on capital income is approximately zero there is an equivalence class of ex post capital income tax rates and bond policies that support a given allocation within this class the optimal ex post capital tax rates can range from close to independently and identically distributed to close to a random walk the tax rate on labor income fluctuates very little and inherits the persistence properties of the exogenous shocks thus there is no presumption that optimal labor tax rates follow a random walk most of the welfare gains realized by switching from a tax system like that of the united states to the ramsey system come from an initial period of high taxation on capital income

portfolio optimization using mixture design of experiments scheduling trades within electricity markets abstract deregulation of the electricity sector has given rise to several approaches to defining optimal portfolios of energy contracts financial tools requiring substantial adjustments are usually used to determine risk and return this article presents a novel approach to adjusting the conditional value at risk cvar metric to the mix of contracts on the energy markets the approach uses mixture design of experiments mde in this kind of experimental strategy the design factors are treated as proportions in a mixture system considered quite adequate for treating portfolios in general instead of using traditional linear programming the concept of desirability function is here used to combine the multi response nonlinear objective functions for mean with the variance of a specific portfolio obtained through mde the maximization of the desirability function is implied in the portfolio optimization generating an efficient recruitment frontier this approach offers three main contributions it includes risk aversion in the optimization routine it assesses interaction between contracts and it lessens the computational effort required to solve the constrained nonlinear optimization problem a case study based on the brazilian energy market is used to illustrate the proposal the numerical results verify the proposal s adequacy

the optimal portfolio problem with coherent risk measure constraints one of the basic problems of applied finance is the optimal selection of stocks with the aim of maximizing future returns and constraining risks by an appropriate measure here the problem is formulated by finding the portfolio that maximizes the expected return with risks constrained by the worst conditional expectation this model is a straightforward extension of the classic markovitz mean variance approach where the original risk measure variance is replaced by the worst conditional expectation the worst conditional expectation with a threshold a of a risk x in brief wcea x is a function that belongs to the class of coherent risk measures these are measures that satisfy a set of properties such as subadditivity and monotonicity that are introduced to prevent some of the drawbacks that affect some other common measures this paper shows that the optimal portfolio selection problem can be formulated as a linear programming instance but with an exponential number of constraints it can be solved efficiently by an appropriate generation constraint subroutine so that only a small number of inequalities are actually needed this method is applied to the optimal selection of stocks in the italian financial market and some computational results suggest that the optimal portfolios are better than the market index 2003 elsevier b v all rights reserved

portfolio optimization under a minimax rule this paper provides a new portfolio selection rule the objective is to minimize the maximum individual risk and we use an l function as the risk measure we provide an explicit analytical solution for the model and are thus able to plot the entire efficient frontier our selection rule is very conservative one of the features of the solution is that it does not explicitly involve the covariance of the asset returns

globalizing carbon lock in this paper extends the arguments surrounding carbon lock in elaborated in unruh energy policy 28 2000 817 30 2002 317 to countries currently undergoing industrialization it argues that for numerous reasons industrializing countries are unlikely to leapfrog carbon intensive energy development on the contrary carbon lock in may be globalizing and could further constrain climate change mitigation options it is then argued that many policy recommendations ignore carbon lock in possibly limiting their potential for successful implementation the paper then discusses four policy approaches that appear to have advantages given lock in conditions it is recognized however that relative ease of implementation does not necessarily equate with superiority instead it is merely a path dependent outcome of past development decisions pursuing policies on the basis of relative implementation ease may help address the issue of climate change but could also result in sub optimal outcomes along other dimensions of sustainable development

optimal fiscal and monetary policy some recent results this paper studies the quantitative properties of fiscal and monetary policy in business cycle models in terms of fiscal policy optimal labor tax rates are virtually constant and optimal capital income tax rates are close to zero on average in terms of monetary policy the friedman rule is optimal nominal interest rates are zero and optimal monetary policy is activist in the sense that it responds to shocks to the economy

a global game with strategic substitutes and complements abstract we study a global game in which actions are strategic complements over some region and strategic substitutes over another region an agent s payoff depends on a market fundamental and the actions of other agents if the degree of congestion is sufficiently large agents strategies are non monotonic in their signal about the market fundamental in this case a signal that makes them believe that the market fundamental is more favorable for an action may make them less likely to take the action because of the risk of overcrowding

managing risk in multi asset class multimarket central counterparties the core approach abstract multi asset class multimarket central counterparties ccps are becoming less uncommon as a result of merges between specialized single asset class single market ccps and market demands for greater capital efficiency yet traditional ccp risk management models often lack the necessary sophistication to estimate potential losses relative to the closeout process of a defaulter s portfolio in a multi asset class multimarket environment as a result multi asset class multimarket ccps usually rely on a simplified silo approach for risk calculation which not only fails to deliver efficiency but may also increase systemic risk the core closeout risk evaluation approach on the other hand provides conceptual and mathematical tools necessary for robust and efficient central counterparty risk evaluation in multi asset class and multimarket environments acknowledging the portfolio dynamics involved in the closeout process as well as important real life market frictions

inter pattern speculation beyond minority majority and games abstract a new simple model of financial market is proposed based on the sequential and inter temporal nature of trader trader interaction and on a new simple trading strategy space in this pattern based speculation model the traders open hold and close their positions explicitly information ecology is strikingly similar to that of the minority game which suggest to reinterpret the latter as a model of synchronisation of predictability exploitation naive and sophisticated agents are shown to give rise to very different phenomenology

living in an imaginary world that looks real abstract in the paper we show using standard approaches general equilibrium modeling and the assumption of complete rationality that the macroeconomic environment is endogenous and is indeterminate specifically it is argued without resorting to sunspot type arguments that microeconomic fundamentals do not suffice to characterize the economy at the macro level in particular we show how perceptions of rational agents of the workings of the economy a shape the environment b affect the environment sufficiently to ensure that rational economic agents find the observed environment consistent with their beliefs even though it is not as a by product we illustrate that endogenous macro uncertainty can arise as an outcome if rational economic agents whose expectations are anchored on endogenous variables expect them to arise finally we show that systematic errors can persist indefinitely under rationality

prospect theory and mean variance analysis the experimental results of prospect theory pt reveal suggest that investors make decisions based on change of wealth rather than total wealth that preferences are s shaped with a risk seeking segment and that probabilities are subjectively distorted this article shows that while pt s findings are in sharp contradiction to the foundations of mean variance mv analysis counterintuitively when diversification between assets is allowed the mv and pt efficient sets almost coincide thus one can employ the mv optimization algorithm to construct ptefficient portfolios the markowitz 1952a tobin 1958 mean variance mv rule is probably the most popular investment decision rule under uncertainty in economics and in finance and it is widely employed by both academics and practitioners the strength of the mv analysis is that in the case of normal return distributions the choice of any expected utility maximizing risk averse individual will be according to the mv rule 1 the mv framework is the foundation of the sharpe 1964 lintner 1965 capital asset pricing model capm which is a cornerstone of modern finance moreover the mv framework provides a very important practical procedure for the construction of efficient portfolios while standard economic theory and in particular mv analysis assume expected utility maximization and risk aversion in a breakthrough article kahneman and tversky 1979 show that the actual behavior of individuals systematically and consistently violates these

risk management strategies via minimax portfolio optimization recent extreme economic developments nearing a worst case scenario motivate further examination of minimax linear programming approaches for portfolio optimization risk measured as the worst case return is employed and a portfolio from maximizing returns subject to a risk threshold is constructed minimax model properties are developed and parametric analysis of the risk threshold connects this model to expected value along a continuum revealing an efficient frontier segmenting investors by risk preference divergence of minimax model results from expected value is quantified and a set of possible prior distributions expressing a degree of knightian uncertainty corresponding to risk preference determined the minimax model will maximize return with respect to one of these prior distributions providing valuable insight regarding an investor s risk attitude and decision behavior linear programming models for financial firms to assist individual investors to hedge against losses by buying insurance and a model for designing variable annuities are proposed

how vulnerable is the emissions market to transaction costs an abms approach abstract the impact of transaction costs on the early emissions trading market is examined by applying an agent based model and simulation abms approach for a realistic model set up bounded rationality stochastic characteristics and learning by doing are considered in our search processes marginal abatement cost parameters are obtained from yoo et al 2010 which is an experimental study on the emissions trading in the korean power sector sensitivity analyses are performed on market performance indices with regard to transaction cost parameters which represent scales and the learning elasticities of transaction costs a total of 960 simulations were run in this sensitivity analysis sensitivity analysis results consistently show that higher transaction costs worsen market performance the most remarkable finding in these results is that welfare performance of all the transactions decreases by up to 50 as the scale parameters of transaction costs increase implying that welfare gain from introducing emissions trading disappears significantly however with learning curve effect welfare performance could be regained by up to 26 in sum although transaction costs significantly encroach upon trade gains at the early stage based on our simulation results the welfare loss by way of transaction costs is lessened as the knowledge of market participants progresses

coordination through social learning in a general equilibrium model this paper analyses coordination through social learning in a general equilibrium model we use a fully decentralized economy in which households and firms exchange labour and consumption goods in the corresponding markets with potential rationing their strategies are updated through an evolutionary learning process based on imitation and random experimenting this learning process induces substantial coordination failures especially between firms which lead almost systematically to below equilibrium output levels and social welfare losses the main underlying mechanism is a self reinforcing uneven distribution of households income which results in a lack of aggregate demand

expectational diversity in monetary economies abstract we investigate an overlapping generations monetary economy in which expectations depend upon backward looking predictors of the future price level we use discrete choice theory to model how agents select a predictor based on its past forecast error letting the number of available predictors tend to infinity we obtain the large type limit of the system taking the large type limit dramatically reduces the number of free parameters while maintaining the expectational diversity which we argue is necessary for constructing plausible learning based models the model s dynamics are strongly influenced by the intensity of choice which measures how sensitive an agent s predictor choice is to differences in forecast errors across predictors when the intensity of choice is low the monetary steady state is stable as the intensity of choice increases and if certain parametric restrictions are met the system undergoes a hopf bifurcation in which case we document the existence of highly irregular equilibrium price paths

fuzzy inductive reasoning expectation formation and the behavior of security prices abstract this paper extends the santa fe artificial stock market model sfasm studied by lebaron arthur and palmer 1999 journal of economic dynamics and control 23 1487 1516 in two important directions first some might question whether it is reasonable to assume that traders are capable of handling a large number of rules each with numerous conditions as is assumed in the sfasm we demonstrate that similar results can be obtained even after severely limiting the reasoning process we show this by allowing agents the ability to compress information into a few fuzzy notions which they can in turn process and analyze with fuzzy logic second lebaron et al have reported that the kurtosis of their simulated stock returns is too small as compared to real data we demonstrate that with a minor modification to how traders go about deciding which of their prediction rules to rely on when making demand decisions the model can in fact produce return kurtosis that is comparable to that of actual returns data

the price dynamics of common trading strategies a deterministic trading strategy can be regarded as a signal processing element that uses external information and past prices as inputs and incorporates them into future prices this paper uses a market maker based method of price formation to study the price dynamics induced by several commonly used financial trading strategies showing how they amplify noise induce structure in prices and cause phenomena such as excess and clustered volatility

optimal fiscal and monetary policy under sticky prices this paper studies optimal fiscal and monetary policy under sticky product prices the theoretical framework is a stochastic production economy without capital the government finances an exogenous stream of purchases by levying distortionary income taxes printing money and issuing one period nominally risk free bonds the main findings of the paper are first for a miniscule degree of price stickiness i e many times below available empirical estimates the optimal volatility of inflation is near zero this result stands in stark contrast with the high volatility of inflation implied by the ramsey allocation when prices are flexible the finding is in line with a recent body of work on optimal monetary policy under nominal rigidities that ignores the role of optimal fiscal policy second even small deviations from full price flexibility induce near random walk behavior in government debt and tax rates third sluggish price adjustment raises the average nominal interest rate above the one called for by the friedman rule finally an interest rate feedback rule whereby the nominal interest rate depends on inflation and output fits well the data emanating from the ramsey economy however the fitted rule is not of the taylor type for the implied inflation coefficient is less than one and close to zero and the output coefficient is negative jel classification e52 e61 e63

robust and pareto optimality of insurance contracts the optimal insurance problem represents a fast growing topic that explains the most efficient contract that an insurance player may get the classical problem investigates the ideal contract under the assumption that the underlying risk distribution is known i e by ignoring the parameter and model risks taking these sources of risk into account the decision maker aims to identify a robust optimal contract that is not sensitive to the chosen risk distribution we focus on value at risk var and conditional value at risk cvar based decisions but further extensions for other risk measures are easily possible the worst case scenario and worst case regret robust models are discussed in this paper which have been already used in robust optimisation literature related to the investment portfolio problem closed form solutions are obtained for the var worst case scenario case while linear programming lp formulations are provided for all other cases a caveat of robust optimisation is that the optimal solution may not be unique and therefore it may not be economically acceptable i e pareto optimal this issue is numerically addressed and simple numerical methods are found for constructing insurance contracts that are pareto and robust optimal our numerical illustrations show weak evidence in favour of our robust solutions for var decisions while our robust methods are clearly preferred for cvar based decisions

the reality game abstract we introduce an evolutionary game with feedback between perception and reality which we call the reality game it is a game of chance in which the probabilities for different objective outcomes e g heads or tails in a coin toss depend on the amount wagered on those outcomes by varying the reality map which relates the amount wagered to the probability of the outcome it is possible to move continuously from a purely objective game in which probabilities have no dependence on wagers to a purely subjective game in which probabilities equal the amount wagered we study self reinforcing games in which betting more on an outcome increases its odds and self defeating games in which the opposite is true this is investigated in and out of equilibrium with and without rational players and both numerically and analytically we introduce a method of measuring the inefficiency of the game similar to measuring the magnitude of the arbitrage opportunities in a financial market we prove that the inefficiency converges to equilibrium as a power law with an extremely slow rate of convergence the more subjective the game the slower the convergence

optimal fiscal and monetary policy with sticky prices in this paper i consider the role of state contingent inflation as a fiscal shock absorber in an economy with nominal rigidities i study the ramsey equilibrium in a monetary model with distortionary taxation nominal non state contingent debt and sticky prices with sticky prices the ramsey planner must balance the shock absorbing benefits of state contingent inflation against the associated resource misallocation costs for government spending processes resembling post war experience introducing sticky prices generates striking departures in optimal policy from the case with flexible prices for even small degrees of price rigidity optimal policy displays very little volatility in inflation tax rates display greater volatility compared to the model with flexible prices with sticky prices tax rates and real government debt exhibit behavior similar to a random walk for government spending processes resembling periods of intermittent war and peace optimal policy displays extreme inflation volatility even when the degree of price rigidity is large as the variability in government spending increases smoothing tax distortions across states of nature becomes increasingly important and the shock absorber role of inflation is accentuated

introduction to the special issue on agent based computational economics abstract a brief overview of agent based computational economics ace is given followed by a synopsis of the articles included in this special issue on ace and in a companion special issue on ace scheduled to appear in computational economics