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The Period Of Financial Distress In Speculative Markets: Interacting Heterogeneous Agents And Financial Constraints

  • Gallegati, Mauro
  • Palestrini, Antonio
  • Rosser, J. Barkley

We investigate how stochastic asset price dynamics with herding and financial constraints explains the presence of a period of financial distress (PFD) following the peak and preceding the crash of a bubble [Charles P. Kindleberger, Manias, Panics, and Crashes: A History of Financial Crisis , 4th ed. (New York: Wiley, 2000, Appendix B)] as common among most major historical speculative bubbles. Simulations show that the PFD is due to (1) agents' wealth distribution dynamics and (2) positive and sufficiently high transaction costs generating losses for a significant mass of the agents' distribution after the peak of the bubble. The use of transaction costs to get the result is only a modeling tool. Many other mechanisms—able to generate losses for a large mass of the agents' distribution in periods in which financial constraints bind—can produce the same result. The paper also shows how the PFD is affected by a variation of the sensitivity of price to the excess demand and by the switching strategy.

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Article provided by Cambridge University Press in its journal Macroeconomic Dynamics.

Volume (Year): 15 (2011)
Issue (Month): 01 (February)
Pages: 60-79

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Handle: RePEc:cup:macdyn:v:15:y:2011:i:01:p:60-79_09
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  1. Kaizoji, Taisei, 2000. "Speculative bubbles and crashes in stock markets: an interacting-agent model of speculative activity," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 287(3), pages 493-506.
  2. J. Bradford De Long & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, 1989. "Positive Feedback Investment Strategies and Destabilizing Rational Speculation," NBER Working Papers 2880, National Bureau of Economic Research, Inc.
  3. Day, R. & Huang, W., 1988. "Bulls, Bears And Market Sheep," Papers m8822, Southern California - Department of Economics.
  4. Carl Chiarella & Mauro Gallegati & Roberto Leombruni & Antonio Palestrini, 2003. "Asset Price Dynamics among Heterogeneous Interacting Agents," Computational Economics, Society for Computational Economics, vol. 22(2), pages 213-223, October.
  5. William A. Brock, 1993. "Pathways to randomness in the economy: Emergent nonlinearity and chaos in economics and finance," Estudios Económicos, El Colegio de México, Centro de Estudios Económicos, vol. 8(1), pages 3-55.
  6. Carl Chiarella & Xue-Zhong He, 1999. "Heterogeneous Beliefs, Risks and Learning in a Simple Asset Pricing Model," Research Paper Series 18, Quantitative Finance Research Centre, University of Technology, Sydney.
  7. Harrison Hong & Jeremy C. Stein, 2003. "Differences of Opinion, Short-Sales Constraints, and Market Crashes," Review of Financial Studies, Society for Financial Studies, vol. 16(2), pages 487-525.
  8. Tirole, Jean, 1982. "On the Possibility of Speculation under Rational Expectations," Econometrica, Econometric Society, vol. 50(5), pages 1163-81, September.
  9. Carl Chiarella, 1992. "The Dynamics of Speculative Behaviour," Working Paper Series 13, Finance Discipline Group, UTS Business School, University of Technology, Sydney.
  10. Bischi, Gian-Italo & Gallegati, Mauro & Gardini, Laura & Leombruni, Roberto & Palestrini, Antonio, 2006. "Herd Behavior And Nonfundamental Asset Price Fluctuations In Financial Markets," Macroeconomic Dynamics, Cambridge University Press, vol. 10(04), pages 502-528, September.
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