2009/06/08 by Matteo Marsili, Marsili, Matteo
Economics, Econometrics and Finance · #FOS: Economics and business #General Finance (q-fin.GN) #Pricing of Securities (q-fin.PR) #Statistical Finance (q-fin.ST) #q-fin.GN #q-fin.PR #q-fin.ST
paper · pdf · doi:10.48550/arxiv.0906.1462
22 pages, 4 figures
arxiv created 2009/06/08 · arxiv updated 2009/12/01
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, even in the ideal case of perfect competition, where full information is available to all market participants, the equilibrium develops a marked vulnerability (or susceptibility) to market imperfections, as markets approach completeness and transaction costs vanish. The decrease in transaction costs arises because financial institutions exploit trading instruments to hedge other instruments. This entails trading volumes in the interbank market which diverge in the limit of complete markets. These results suggest that the proliferation of financial instruments exacerbates the effects of market imperfections, calling for theories of market as interacting systems. From a different perspective, in order to prevent an escalation of perverse effects, markets may necessitate institutional structures which are more and more conspicuous as their complexity expands.