Eroding market stability by proliferation of financial instruments

@article{Caccioli2008ErodingMS,
  title={Eroding market stability by proliferation of financial instruments},
  author={Fabio Caccioli and Matteo Marsili and Pierpaolo Vivo},
  journal={The European Physical Journal B},
  year={2008},
  volume={71},
  pages={467-479}
}
We contrast Arbitrage Pricing Theory (APT), the theoretical basis for the development of financial instruments, with a dynamical picture of an interacting market, in a simple setting. The proliferation of financial instruments apparently provides more means for risk diversification, making the market more efficient and complete. In the simple market of interacting traders discussed here, the proliferation of financial instruments erodes systemic stability and it drives the market to a critical… 
View on Springer
arxiv.org
69 Citations
Highly Influential Citations
2
Background Citations
23
Results Citations
1

69 Citations

Spiraling toward market completeness and financial instability
I study the limit of a large random economy, where a set of consumers invests in financial instruments engineered by banks, in order to optimize their future consumption. This exercise shows that,…
Efficiency and Stability in Complex Financial Markets
The authors study a simple model of an asset market with informed and non-informed agents. In the absence of non-informed agents, the market becomes information efficient when the number of traders…
Complexity and financial stability in a large random economy
I study the limit of a large random economy, in the ideal case of perfect competition, where full information is available to all market participants, and where a set of consumers invests in…
Information Efficiency and Financial Stability
Abstract The authors study a simple model of an asset market with informed and non-informed agents. In the absence of non-informed agents, the market becomes information efficient when the number of…
Statistical mechanics and financial markets: Antagony between derivatives and market self-regulation
Financial crisis dynamics: attempt to define a market instability indicator
The impact of increasing leverage in the economy produces hyperreaction of market participants to variations of their revenues. If the income of banks decreases, they mass-reduce their lendings; if…
When Micro Prudence Increases Macro Risk: The Destabilizing Effects of Financial Innovation, Leverage, and Diversification
TLDR
The model shows that when financial innovation reduces the cost of diversification below a given threshold, the strength and coordination of feedback effects increase, triggering a transition from a stationary dynamics of price returns to a nonstationary one characterized by steep growths and plunges of market prices.
Asset diversification and systemic risk in the financial system
In this study, we have developed a complex network system from the obligation links among banks and links created by portfolio overlaps to simulate the behavior of the financial system. In the…
Critical reflexivity in financial markets: a Hawkes process analysis
We model the arrival of mid-price changes in the E-mini S&P futures contract as a self-exciting Hawkes process. Using several estimation methods, we find that the Hawkes kernel is power-law with a…
Size and complexity in model financial systems
TLDR
The results highlight that the importance of relatively large, well-connected banks in system stability scales more than proportionately with their size: the impact of their collapse arises not only from their connectivity, but also from their effect on confidence in the system.
...
...

References

SHOWING 1-10 OF 56 REFERENCES
Dynamic instability in a phenomenological model of correlated assets
We show that financial correlations exhibit a non-trivial dynamic behaviour. We introduce a simple phenomenological model of a multi-asset financial market, which takes into account the impact of…
More Hedging Instruments May Destabilize Markets
This paper formalizes the idea that more hedging instruments may destabilize markets when traders are heterogeneous and adapt their behavior according to experience based reinforcement learning. We…
General Black-Scholes models accounting for increased market volatility from hedging strategies
Increases in market volatility of asset prices have been observed and analysed in recent years and their cause has generally been attributed to the popularity of portfolio insurance strategies for…
Self Referential Behaviour, Overreaction and Conventions in Financial Markets
We study a generic model for self-referential behaviour in financial markets, where agents attempt to use some (possibly fictitious) causal correlations between a certain quantitative information and…
How Markets Slowly Digest Changes in Supply and Demand
In this article we revisit the classic problem of tatonnement in price formation from a microstructure point of view, reviewing a recent body of theoretical and empirical work explaining how…
Macro Lessons from Microstructure
Empirical research on the microeconomics of currency markets, an area known sometimes as 'currency market microstructure,' has taken off in the past decade. This paper extracts from this research…
A Market-Induced Mechanism for Stock Pinning
We propose a model to describe stock pinning on option expiration dates. We argue that if the open interest on a particular contract is unusually large, delta-hedging in aggregate by floor…
A market-induced mechanism for stock pinning
Abstract We propose a model to describe stock pinning on option expiration dates. We argue that if the open interest on a particular contract is unusually large, delta-hedging in aggregate by floor…
Scaling and criticality in a stochastic multi-agent model of a financial market
Financial prices have been found to exhibit some universal characteristics that resemble the scaling laws characterizing physical systems in which large numbers of units interact. This raises the…
Effects of Tobin Taxes in Minority Game markets
...
...