This is being sent to three lists, although it is an immediate followup to a thread on pkt (longish).
Dave Colander asked if institutions can limit the instabilities associated with chaos and complexity (chaoplexity), a la the famous "corridor of stability" idea of Axel Leijonhufvud. I said maybe, but then said that they may also lead to greater instability. I wish to follow up:
1) The corridor of stability has inherent in it the possibility that by widening the corridor a bit, thus allowing more local volatility, one may gain more boundedness or global stability of the system. This has a counterpart in ecological theory in the alleged tradeoff between "stability" and "resilience" enunciated by C.S. Holling. A simple example is the oak tree (stable but not resilient in a hurricane) versus the palm tree (unstable but resilient in a hurricane) or elephant populations (stable but unresilient) versus sheep blowfly populations (potentially chaotic but resilient). There are many chaotic systems that are actually very resilient, if locally unstable, including our brains (when we aren't bonkers).
2) An example of an institution trying to increase stability but reducing resilience might be the the government bank insurers, or in Japan and "non-opaque" banking systems the central authorities more generally. In the US this was posed as the "moral hazard" problem of FSLIC in that when banks or lenders or borrowers or all of them felt safe because of the government agency covering for them they engaged in reckless behavior that eventually brought the system to a much greater degree of crisis, especially as we are now seeing in East Asia where lots of lenders and borrowers counted on their governments to maintain pegs to the US dollar. Similar such complacency is what we see at the late stages of speculative asset bubbles a la the Ponzi analysis of Minsky.
2) Nevertheless the fear of actual financial market chaos is currently playing a role in some major institution changing going on right now, in particular European monetary unification. One of the most prominent advocates for the EMU all along has been Paul de Grauwe of the University of Leuven in Belgium. I gave a talk there in 1990 on chaos theory right after he and Kris Vansanten at CEPR in London had published a paper showing how chaotic dynamics could easily arise in forex markets. This was followed up by a book by de Grauwe, Embrechts, and Wachter in 1993 on Chaotic Dynamics in Foreign Exchange Markets that developed the argument much further and has been much cited. I personally am convinced that de Grauwe sees the EMU as the way to KILL THE CHAOS in the European forex markets.
4) Finally I note that in the kinds of models of financial markets where there is a struggle between "fundamentalists" and "chartists" or something like that (which is what is going on the de Grauwe et al models) much more complex dynamics are possible than mere chaos, e.g. fractal basin boundaries (eeeeek!) and some other pretty hairy stuff. A paper giving the full array of this stuff is William A. Brock and Cars H. Hommes, "A Rational Route to Randomness," _Econometrica_, 1997, vol. 65, pp. 1059-1095. Barkley Rosser Professor of Economics James Madison University Harrisonburg, VA 22807 USA
-- Rosser Jr, John Barkley rosserjb at jmu.edu