Divergent Behavior in Markets with Idiosyncratic Private Information

Abstract

Perpetually evolving divergent trading strategies is the natural consequence of a market with idiosyncratic private information. In the face of intrinsic uncertainty about other traders' strategies, participants resort to learning and adaptation to identify and exploit profitable trading opportunities. Model-consistent use of market-based information generally improves price performance but can inadvertently produce episodes of sudden mispricing. The paper examines the impact of trader's use of information and bounded rationality on price efficiency.

Keywords: Heterogeneous Agents, Efficient Markets, Learning, Dynamics, Computational Economics

JEL Classification: G14, C62, D82