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In both finance and economics, quantitative models are usually studied asisolated mathematical objects --- most often defined by very strong simplifyingassumptions concerning rationality, efficiency and the existence ofdisequilibrium adjustment mechanisms. This raises the important question of howsensitive such models might be to real-world effects that violate theassumptions. We show how the consequences of rational behavior caused byperverse incentives, as well as various irrational tendencies identified bybehavioral economists, can be systematically and consistently introduced intoan agent-based model for a financial asset. This generates a class of modelswhich, in the special case where such effects are absent, reduces to geometricBrownian motion --- the usual equilibrium pricing model. Thus we are able tonumerically perturb a widely-used equilibrium pricing model market andinvestigate its stability. The magnitude of such perturbations in real marketscan be estimated and the simulations imply that this is far outside thestability region of the equilibrium solution, which is no longer observed.Indeed the price fluctuations generated by endogenous dynamics, are in goodgeneral agreement with the excess kurtosis and heteroskedasticity of actualasset prices. The methodology is presented within the context of a financialmarket. However, there are close links to concepts and theories from bothmicro- and macro-economics including rational expectations, Soros' theory ofreflexivity, and Minsky's theory of financial instability.

How sensitive are equilibrium pricing models to real-world distortions?