Agent-based model , financial markets , instability , balance sheets , leverage , size distribution , credit frictions
Abstract:
We develop an agent-based model in which heterogenous and bound-
edly rational agents interact by trading a risky asset at an endoge-
nously 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. The introduction of balance sheets
and debt into an agent-based setup is relatively new to the litera-
ture and allows us to tackle several research questions that are mostly
inaccessible following conventional methodology, especially represen-
tative agent models. A number of findings emerge when simulating
the model. We find that the empirically observable log-normal distri-
bution of bank balance sheet size naturally emerges and that higher
levels of leverage lead to a greater inequality among agents. When fur-
ther analyzing the relationship between leverage and balance sheets,
we observe that decreasing credit frictions result in an increasingly
procyclical behavior of leverage, which is typical for investment banks.
We show how decreasing credit frictions increase volatility but decrease
the number of bankruptcies.
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