Regulatory Medicine Against Financial Market Instability: What Helps And What Hurts?
Do we know if a short selling ban or a Tobin Tax result in more stable asset prices? Or do they in fact make things worse? Just like medicine regulatory measures in financial markets aim at improving an already complex system. And just like medicine these interventions can cause side effects which are even harder to assess when taking the interplay with other measures into account. In this paper an agent based stock market model is built that tries to find answers to the questions above. In a stepwise procedure regulatory measures are introduced and their implications on market liquidity and stability examined. Particularly, the effects of (i) a ban of short selling (ii) a mandatory risk limit, i.e. a Value-at-Risk limit, (iii) an introduction of a Tobin Tax, i.e. transaction tax on trading, and (iv) any arbitrary combination of the measures are observed and discussed. The model is set up to incorporate non-linear feedback effects of leverage and liquidity constraints leading to fire sales and escape dynamics. In its unregulated version the model outcome is capable of reproducing stylised facts of asset returns like fat tails and clustered volatility. Introducing regulatory measures shows that only a mandatory risk limit is beneficial from every perspective, while a short selling ban - though reducing volatility - increases tail risk. The contrary holds true for a Tobin Tax: it reduces the occurrence of crashes but increases volatility. Furthermore, the interplay of measures is not negligible: measures block each other and a well chosen combination can mitigate unforeseen side effects. Concerning the Tobin Tax the findings indicate that an overdose can do severe harm.
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Friedman, Daniel & Abraham, Ralph, 2009. "Bubbles and crashes: Gradient dynamics in financial markets," Journal of Economic Dynamics and Control, Elsevier, vol. 33(4), pages 922-937, April.
- B. LeBaron, 2001. "A builder's guide to agent-based financial markets," Quantitative Finance, Taylor & Francis Journals, vol. 1(2), pages 254-261.
- G. Ehrenstein & F. Westerhoff & D. Stauffer, 2005.
"Tobin tax and market depth,"
Taylor & Francis Journals, vol. 5(2), pages 213-218.
- Lux, Thomas, 1998. "The socio-economic dynamics of speculative markets: interacting agents, chaos, and the fat tails of return distributions," Journal of Economic Behavior & Organization, Elsevier, vol. 33(2), pages 143-165, January.
- James Tobin, 1978.
"A Proposal for International Monetary Reform,"
Cowles Foundation Discussion Papers
506, Cowles Foundation for Research in Economics, Yale University.
- Hanke, Michael & Huber, Jürgen & Kirchler, Michael & Sutter, Matthias, 2010.
"The economic consequences of a Tobin tax--An experimental analysis,"
Journal of Economic Behavior & Organization,
Elsevier, vol. 74(1-2), pages 58-71, May.
- Michael Hanke & J?rgen Huber & Michael Kirchler & Matthias Sutter, 2007. "The economic consequences of a Tobin tax - An experimental analysis," Working Papers 2007-18, Faculty of Economics and Statistics, University of Innsbruck.
- De Grauwe, Paul & Grimaldi, Marianna, 2006. "Exchange rate puzzles: A tale of switching attractors," European Economic Review, Elsevier, vol. 50(1), pages 1-33, January.
- Paolo Pellizzari & Frank Westerhoff, 2009.
"Some effects of transaction taxes under different microstructures,"
- Pellizzari, Paolo & Westerhoff, Frank, 2009. "Some effects of transaction taxes under different microstructures," Journal of Economic Behavior & Organization, Elsevier, vol. 72(3), pages 850-863, December.
- Paolo Pellizzari & Frank Westerhoff, 2009. "Some effects of transaction taxes under different microstructures," Working Papers 190, Department of Applied Mathematics, Università Ca' Foscari Venezia.
- Paolo Pelizzari & Frank Westerhoff, 2007. "Some Effects of Transaction Taxes Under Different Microstructures," Research Paper Series 212, Quantitative Finance Research Centre, University of Technology, Sydney.
- R. Cont, 2001. "Empirical properties of asset returns: stylized facts and statistical issues," Quantitative Finance, Taylor & Francis Journals, vol. 1(2), pages 223-236.
- Frank Westerhoff, 2003.
"Heterogeneous traders and the Tobin tax,"
Journal of Evolutionary Economics,
Springer, vol. 13(1), pages 53-70, 02.
- Mannaro, Katiuscia & Marchesi, Michele & Setzu, Alessio, 2008. "Using an artificial financial market for assessing the impact of Tobin-like transaction taxes," Journal of Economic Behavior & Organization, Elsevier, vol. 67(2), pages 445-462, August.
- Challet, Damien & Marsili, Matteo & Zhang, Yi-Cheng, 2001.
"Stylized facts of financial markets and market crashes in Minority Games,"
Physica A: Statistical Mechanics and its Applications,
Elsevier, vol. 294(3), pages 514-524.
- Damien Challet & Matteo Marsili & Yi-Cheng Zhang, 2001. "Stylized facts of financial markets and market crashes in Minority Games," Papers cond-mat/0101326, arXiv.org.
- J. B. Satinover & D. Sornette, 2007. "”Illusion of control” in Time-Horizon Minority and Parrondo Games," The European Physical Journal B: Condensed Matter and Complex Systems, Springer;EDP Sciences, vol. 60(3), pages 369-384, December.
When requesting a correction, please mention this item's handle: RePEc:arx:papers:1011.6284. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (arXiv administrators)
If references are entirely missing, you can add them using this form.