Abstract
We describe an agent-based model of a financial market with a stock and a bond. Agents compete in repeated rounds, decide whether to acquire costly information and can pick one of 16 strategies to allocate their investments, under evolutionary pressure driven by the comparison of the realized short-term revenues from trading. We show that, while informed traders survive in some cases, the equilibrium shares are strongly biased in favor of strategies that make little use of information and systematically overestimate the riskiness of the stock. As a consequence, the majority of the population ends up in buying fewer stocks than would be otherwise expected or deemed rational. This evolutionary dynamics offers a novel way to explain the equity premium puzzle first described by Mehra and Prescott (The equity premium: A puzzle. Journal of Monetary Economics 1985), according to which it’s hard to find reasons for the widespread lack of investment in risky assets. Evolution based on a straightforward comparison of revenues is a simple and cognitively appealing avenue to reach a population of traders using (over-)cautious strategies to curb the risk of long-term “financial extinction”. Simulations run in NetLogo also demonstrate that very little information may be used in noisy markets or when the cost of information is substantial.
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Notes
- 1.
The code is available on the website of the authors.
- 2.
All simulations are initialized setting the bits in \(\textbf{b}\) randomly in \(\{0,1\}\).
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Acknowledgements
We thank Giulia Iori for useful discussion. Two anonymous reviewers provided very useful suggestions but we are responsible for any error. Paolo Pellizzari is partially supported by ITN project EPOC “Economic Policies in Complex Environments” under the Marie Skłodowska-Curie grant agreement No 956107. The VERA Center of Ca’ Foscari University of Venice funded Francesco Franz and Carlo Bellato who provided technical support. This work benefited from the inspiring FFSS facilities located in Trevignano-Signoressa (VE).
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Gerotto, L., Pellizzari, P., Tolotti, M. (2023). The Equity Premium Puzzle: An Application of an Agent-Based Evolutionary Model. In: Squazzoni, F. (eds) Advances in Social Simulation. ESSA 2022. Springer Proceedings in Complexity. Springer, Cham. https://doi.org/10.1007/978-3-031-34920-1_36
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