Liquidity and Speculation
Liquidity and Speculation
Two models of market behavior are contrasted, one characterized by negative feedbacks, where the agent's relationship to the commodities being exchanged is determined independently of the market, the other by positive feedbacks, where the same relationship is no longer assumed to be determined in advance of transactions. The fundamentalist model, corresponding to the Walrasian framework, is assumed by neoclassical economists to be ideally suited to analyzing financial markets. This is shown to be mistaken, and their inability to explain financial competition shown to be due to a misunderstanding of liquidity. The main properties of liquidity are examined instead in relation to the self-referential model, which provides a simple explanation of excessive volatility and speculative bubbles. Speculation is analyzed as the product of emergent and collective perceptions known as conventions. The behavior of governments and markets is conventional since both regard liquidity as the supreme arbiter of economic exchange.
Keywords: bubbles, conventions, excessive volatility, fundamentalist model, liquidity, negative/positive feedbacks, self-referential model, speculation
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