TY - JOUR

T1 - Computational complexity and information asymmetry in financial products

AU - Arora, Sanjeev

AU - Barak, Boaz

AU - Brunnermeier, Markus

AU - Ge, Rong

PY - 2011/5/1

Y1 - 2011/5/1

N2 - Computational complexity studies intractable problems like NP-complete problems, which are conjectured to require more computational resources than can be provided by the fastest computers. The intractability of this problem leads to a concrete realization of information asymmetry. Computational complexity immediately implies the existence of hard-to-price derivatives, albeit unnatural ones. Consider for example a derivative whose contract contains a 10,000 digit integer n and has a nonzero payoff if the unemployment rate next January, when rounded to the nearest integer, is the last digit of a factor of n. Computational complexity can be related to the bounded rationality concept in economics. A seller who knows he has a non-lemon would be unwilling to sell for $800, and would therefore withdraw from the market. The market would be left only with lemons, and knowing this, buyers would refuse to buy any car.

AB - Computational complexity studies intractable problems like NP-complete problems, which are conjectured to require more computational resources than can be provided by the fastest computers. The intractability of this problem leads to a concrete realization of information asymmetry. Computational complexity immediately implies the existence of hard-to-price derivatives, albeit unnatural ones. Consider for example a derivative whose contract contains a 10,000 digit integer n and has a nonzero payoff if the unemployment rate next January, when rounded to the nearest integer, is the last digit of a factor of n. Computational complexity can be related to the bounded rationality concept in economics. A seller who knows he has a non-lemon would be unwilling to sell for $800, and would therefore withdraw from the market. The market would be left only with lemons, and knowing this, buyers would refuse to buy any car.

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U2 - 10.1145/1941487.1941511

DO - 10.1145/1941487.1941511

M3 - Article

AN - SCOPUS:79955416334

VL - 54

SP - 101

EP - 107

JO - Communications of the ACM

JF - Communications of the ACM

SN - 0001-0782

IS - 5

ER -