Trading Complex Risks
88 Pages Posted: 12 Dec 2017 Last revised: 24 Feb 2021
There are 2 versions of this paper
Trading Complex Risks
Trading Complex Risks
Date Written: June 4, 2018
Abstract
This paper studies how complexity impacts markets’ ability to aggregate information and distribute risks. I amend fundamental asset pricing theory to reflect agents’ imperfect knowledge about complex dividend distributions and test its clear-cut predictions in the laboratory. Market equilibria corroborate complexity-averse trading behavior. Despite being overpriced, markets efficiently share complex risks between buyers and sellers. While complexity induces noise in individual trading decisions, market outcomes remain theory-consistent. This striking feature reconciles with a random choice model, where bounds on rationality are reinforced by complexity. Furthermore, apparent self-awareness of estimation biases increases the efficiency and reduces the fluctuations of market-clearing prices.
Keywords: Complexity, risk sharing, information aggregation, bounded rationality, discontinuous trading
JEL Classification: G12, G14, G41
Suggested Citation: Suggested Citation