(Ir)rational explorers in the financial jungle

In recent decades, several scholars have formalised Minsky’s profound insight that increasing financial fragility accompanies periods of economic stability. It must be noted, however, that incisive assessments of the role of expectations formation with heterogeneous agents has been provided only by those contributions focusing on stock-market prices. Macroeconomic models dealing with debt dynamics, on the other hand, have not yet presented such an account. It is our purpose to fill this gap in the literature by formalising switches between different heuristics in a small-scale evolutionary agent-based model where solvency aspects matter. Our system generates time-series that reproduce important empirical stylised facts such as fat tails and asymmetric skewness. We show how changes in risk perception are amplified in an asymmetric way by the right-skewed solvency constraint, leading to output fluctuations compatible with the possibility of crashes. Moreover, while the destabilising role of extrapolative behaviour is part of conventional wisdom, we discuss the conditions under which fundamentalists, the existence of resource constraints, and the time horizon of the economic unit may also lead to instability.