Using Multi-Agent Simulation to Understand Trading Dynamics of a Derivatives Market

A fundamental question that arises in derivative pricing is why investors trade at a fair price. A common opinion attributes trading to differences in the beliefs that market participants have about the future development of market prices. We develop a model that accounts for investors' pre-existing liability structures and enables us to show, through a series of experiments, that investors trade even when their belief structures are identical and accurate.More generally, we show that multi-agent simulation of a financial market provides a mechanism for conducting experiments that shed light on fundamental properties of the market. As all processes in financial markets (including decision making) become automated, it becomes crucial to have a mechanism by which we can observe the patterns that emerge from a variety of possible investor behaviors. Our simulator provides this mechanism