Support from the Centre for Economic Policy Research, Stanford, and from the Guggenheim Foundation is acknowledged. ' Rosenberg (rg8nj calls this 'Learning by Using' (see also Atkinson and Stiglitz, 1969). Jet aircraft designs like the Boeing 727, for example, undergo constant modification and they improve significantly in structural soundness, wing design, payload capacity and engine efficiency as they accumulate actual airline adoption and use.

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After two centuries of studying equilibria-static patterns that call for no further behavioral adjustments-economists are beginning to study the general emergence of structures and the unfolding of patterns in the economy. When viewed in out-of-equilibrium formation, economic patterns sometimes simplify into the simple static equilibria of standard economics. More often they are ever changing, showing perpetually novel behavior and emergent phenomena. Complexity portrays the economy not as deterministic, predictable, and mechanistic, but as process dependent, organic, and always evolving.

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We propose a theory of asset pricing based on heterogeneous agents who continually adapt their expectations to the market that these expectations aggregatively create. And we explore the implications of this theory computationally using our Santa Fe artificial stock market.Asset markets, we argue, have a recursive nature in that agents' expectations are formed on the basis of their anticipations of other agents' expectations, which precludes expectations being formed by deductive means. Instead traders continually hypothesize-continually explore-expectational models, buy or sell on the basis of those that perform best, and confirm or discard these according to their performance.Thus individual beliefs or expectations become endogenous to the market, and constantly compete within an ecology of others' beliefs or expectations. The ecology of beliefs co-evolves over time.Computer experiments with this endogenous-expectations market explain one of the more striking puzzles in finance: that market traders often believe in such concepts as technical trading, "market psychology, " and bandwagon effects, while academic theorists believe in market efficiency and a lack of speculative opportunities. Both views, we show, are correct, but within different regimes. Within a regime where investors explore alternative expectational models at a low rate, the market settles into the rationalexpectations equilibrium of the efficient-market literature. Within a regime where the rate of exploration of alternative expectations is higher, the market self-organizes into a complex pattern. It acquires a rich psychology, technical trading emerges, temporary bubbles and crashes occur, and asset prices and trading volume show statistical features-in particular, GARCH behavior-characteristic of actual market data.