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Financial markets and complexity: uncertainty, heterogeneous micro agents and aggregate outcomes

Ziel

The ability of financial markets to bear risk is central to economic welfare and stability. Growth and economic well being is inhibited if financial markets are unable to transfer resources efficiently from the suppliers of liquidity to risk takers or en trepreneurs. Ensuring a proper return to capital and risk is the function of a market and market stability enables proper long run planning and the efficient allocation of resources to productive activities. Despite this we are faced with levels of volat ility considerably in excess of those implied by fundamentals. Markets undergo dramatic crashes and they enable speculative bubbles to develop which lead market prices away from their equilibrium values. Classical Financial Theory which rests on a sing le representative agent model of rational behaviour has been able to make only limited progress in resolving these important practical and policy relevant issues of the apparent instability in financial markets. This proposal seeks to develop an emergi ng alternative paradigm which explicitly emphasises the heterogeneity of the large number of micro agents within markets and allows each agent to adopt rules of behaviour that may be viewed as rational given the complexity of the market environment. Anal ysis of the transfer of information through the market and communication networks between the micro agents extends beyond the role played by the market price and can show how different aggregate market forms and macroscopic behaviour can evolve. Viewing financial markets as very large complex systems borrows substantial intellectual insight and method from similar systems of interacting particles in physical science. The dynamics of the aggregate market may be determined as much by the evolution of orga nisational form as the micro incentives. Complexity seems to be a property of economic organisation not individuals.

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FP6-2003-NEST-PATH
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THE UNIVERSITY OF WARWICK
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