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

Fischer, Thomas ; Riedler, Jesper

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URN: urn:nbn:de:bsz:180-madoc-324258
Document Type: Working paper
Year of publication: 2012
The title of a journal, publication series: ZEW Discussion Papers
Volume: 12-045
Place of publication: Mannheim
Publication language: English
Institution: Sonstige Einrichtungen > ZEW - Leibniz-Zentrum für Europäische Wirtschaftsforschung
MADOC publication series: Veröffentlichungen des ZEW (Leibniz-Zentrum für Europäische Wirtschaftsforschung) > ZEW Discussion Papers
Subject: 330 Economics
Classification: JEL: C63 , D53 , D84,
Keywords (English): 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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