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Finance, Agent Based Modeling in

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Encyclopedia of Complexity and Systems Science

Definition of the Subject

Finance can be broadly defined as studying the allocation of resources over time in an uncertain environment. Consumers are interested in saving part of their current income and transfer it for consumption in the future (e. g., saving for retirement). On the other hand, firms are looking to raise capital to finance productive investments that will payoff in the future. In both decisions, the future is uncertain and individuals and firms are required to evaluate the risks involved in buying an asset (e. g., stocks and bonds) or investing in a project.

The traditional modeling approach in finance is to introduce strong assumptions on the behavior of agents. They are assumed to have perfect knowledge of the structure of the economy and to correctly process the available information. Based on these two assumptions, agents are able to form Rational Expectations (RE) such that their beliefs are not systematically wrong (in other words, the forecasting errors are...

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Abbreviations

Rational expectations (RE):

An assumption often introduced in economic models. It assumes that agents subjective distribution is equal to the true probability distribution of a random variable. The implication is that expectation errors are purely random.

Bounded rationality :

The assumption that agents have limited ability to acquire and process information and to solve complex economic problems. These limitations imply that expectations can diverge from RE.

Efficient markets hypothesis (EMH):

An application of rational expectations to asset prices. The EMH assumes that asset prices reflect all available information. It implies that asset prices behave like a random walk process and their changes are purely random.

Artificial financial markets:

A market populated by agents that have bounded rational expectations and learning from available information. Trading in these markets occurs based on traditional price setting mechanisms or more realistic mechanisms inspired by electronic markets.

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Author information

Authors and Affiliations

  1. Department of Economics and Finance, Baruch College CUNY, New York, USA

    Sebastiano Manzan

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  1. Sebastiano Manzan
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Editor information

Editors and Affiliations

  1. RAMTECH LIMITED, 122 Escalle Lane, Larkspur, CA, 94939, USA

    Robert A. Meyers Ph. D. (Editor-in-Chief) (Editor-in-Chief)

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© 2009 Springer-Verlag

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Manzan, S. (2009). Finance, Agent Based Modeling in. In: Meyers, R. (eds) Encyclopedia of Complexity and Systems Science. Springer, New York, NY. https://doi.org/10.1007/978-0-387-30440-3_201

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