An Agent Based Model for a Double Auction with Convex Incentives

We studied the influence of convex incentives, e.g. option-like compensations, on the behavior of financial markets. Such incentives, usually offered to portfolio managers, have been often considered a potential source of market instability. We built an agent-based model of a double-auction market where some of the agents are endowed with convex contracts. We show that these contracts encourage traders to buy more aggressively, increasing total demand and market prices. Our analysis suggests that financial markets with many managers with convex contracts are more likely to be more unstable and less efficient.