Chair of Monetary Economics and International Finance

Short Summary

Duration

Begin: May 2005

End: April 2008
Participating Universities
  • University of Warwick, UK
  • Abdus Salam International Center For Theoretical Physics, Trieste, Italy
  • University of Cagliari, Italy
  • University of Amsterdam, Netherlands
  • Universite Aix-Marseille, France
  • University of Kiel, Germany
Project Summary

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 entrepreneurs. 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 volatility 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 single representative agent model of rational behaviour, has only been able to make limited progress in resolving these important practical and policy relevant issues of the apparent instability in financial markets. Therefore, the project seeks to develop an emerging 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. Analysis 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 organisational form as the micro incentives. Complexity seems to be a property of economic organisation not individuals.

The proposed research seeks to analyse financial markets as complex systems of interacting heterogeneous agents using tools drawn from mathematics, physics and economics. An important element of the proposal is to incorporate within this an analysis of how human beings take decisions within complex systems of which they have a poor understanding. Hence we will also draw on behavioural motivations and psychology in order to better understand decision making under uncertainty within complex systems.