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Prices, debt and market structure in an agent-based model of the financial market

Fischer, Thomas LU and Riedler, Jesper (2014) In Journal of Economic Dynamics and Control 48. p.95-120
Abstract
We develop an agent-based model in which heterogeneous and boundedly rational agents interact by trading a risky asset at an endogenously set price. Agents are endowed with balance sheets comprising the risky asset as well as cash on the asset side and equity capital as well as debt on the liabilities side. A number of findings emerge when simulating the model: we find that the empirically observable log-normal distribution of bank balance sheet size naturally emerges and that higher levels of leverage lead to a greater inequality among agents. Furthermore, greater leverage increases the frequency of bankruptcies and systemic events. Credit frictions, which we define as the stickiness of debt adjustments, are able to explain a key... (More)
We develop an agent-based model in which heterogeneous and boundedly rational agents interact by trading a risky asset at an endogenously set price. Agents are endowed with balance sheets comprising the risky asset as well as cash on the asset side and equity capital as well as debt on the liabilities side. A number of findings emerge when simulating the model: we find that the empirically observable log-normal distribution of bank balance sheet size naturally emerges and that higher levels of leverage lead to a greater inequality among agents. Furthermore, greater leverage increases the frequency of bankruptcies and systemic events. Credit frictions, which we define as the stickiness of debt adjustments, are able to explain a key difference in the relation between leverage and assets observed for different bank types. Lowering credit frictions leads to an increasingly procyclical behavior of leverage, which is typical for investment banks. Nevertheless, the impact of credit frictions on the fragility of the model financial system is complex. Lower frictions do increase the stability of the system most of the time, while systemic events become more probable. In particular, we observe an increasing frequency of severe liquidity crises that can lead to the collapse of the entire model financial system. (Less)
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author
publishing date
type
Contribution to journal
publication status
published
subject
keywords
agent-based model, financial markets, leverage, systemic risk, credit frictions, C63, D53, D84
in
Journal of Economic Dynamics and Control
volume
48
pages
26 pages
publisher
Elsevier
external identifiers
  • scopus:84909635359
ISSN
0165-1889
DOI
10.1016/j.jedc.2014.08.013
language
English
LU publication?
no
id
94406caf-9ce1-4376-af8a-4461d774bce5
date added to LUP
2017-01-10 10:47:42
date last changed
2017-09-03 05:17:15
@article{94406caf-9ce1-4376-af8a-4461d774bce5,
  abstract     = {We develop an agent-based model in which heterogeneous and boundedly rational agents interact by trading a risky asset at an endogenously set price. Agents are endowed with balance sheets comprising the risky asset as well as cash on the asset side and equity capital as well as debt on the liabilities side. A number of findings emerge when simulating the model: we find that the empirically observable log-normal distribution of bank balance sheet size naturally emerges and that higher levels of leverage lead to a greater inequality among agents. Furthermore, greater leverage increases the frequency of bankruptcies and systemic events. Credit frictions, which we define as the stickiness of debt adjustments, are able to explain a key difference in the relation between leverage and assets observed for different bank types. Lowering credit frictions leads to an increasingly procyclical behavior of leverage, which is typical for investment banks. Nevertheless, the impact of credit frictions on the fragility of the model financial system is complex. Lower frictions do increase the stability of the system most of the time, while systemic events become more probable. In particular, we observe an increasing frequency of severe liquidity crises that can lead to the collapse of the entire model financial system.},
  author       = {Fischer, Thomas and Riedler, Jesper},
  issn         = {0165-1889},
  keyword      = {agent-based model,financial markets,leverage,systemic risk,credit frictions,C63,D53,D84},
  language     = {eng},
  pages        = {95--120},
  publisher    = {Elsevier},
  series       = {Journal of Economic Dynamics and Control},
  title        = {Prices, debt and market structure in an agent-based model of the financial market},
  url          = {http://dx.doi.org/10.1016/j.jedc.2014.08.013},
  volume       = {48},
  year         = {2014},
}