Equilibrium Market Volatility in Imperfect Competition of General Equilibrium

2019.

Levando D. V., Sakharov M.

We develop a theory of equilibrium market volatility in a general equilibrium duopoly with complete information. The resulting economic system possesses a property, which can be described as ‘natural volatility’ of markets, even if players have complete information. Economy is described as a strategic market game where every player has market power as a buyer and a seller. Players are uncertain about each other’s actions, and due to the properties of expected utility maximization there is no convergence of common beliefs of common knowledge to unique mixed strategies equilibrium, hence, rational expectations approach cannot be applied.  Volatility at the market appears from a multiplicity of equilibrium mixed strategies; they cannot be computed precisely, but only approximated. We identify several Pareto-efficient strategies and study induced prices, allocations and payoffs, which are all volatile. 

Keywords: common knowledge, rational expectations, Efficient markets, Strategic Market Games, Ill-Posed Problems, Price Fluctuations, noise trade, sun-spot equilibrium