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THE PERIOD OF FINANCIAL DISTRESS IN SPECULATIVE MARKETS: INTERACTING HETEROGENEOUS AGENTS AND FINANCIAL CONSTRAINTS

Published online by Cambridge University Press:  11 January 2010

Mauro Gallegati ,
Antonio Palestrini  and
J. Barkley Rosser Jr.
Mauro Gallegati
Affiliation:
Università Politecnica della Marche
Antonio Palestrini
Affiliation:
University of Teramo
J. Barkley Rosser Jr.*
Affiliation:
James Madison University
*
Address correspondence to: J. Barkley Rosser, Jr., MSC 0204, James Madison University, Harrisonburg, VA 22807, USA; e-mail: rosserjb@jmu.edu.
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Abstract

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.

Keywords

Period of Financial DistressFinancial ConstraintsHerding Behavior
Type
Articles
Information
Macroeconomic Dynamics , Volume 15 , Issue 1 , February 2011 , pp. 60 - 79
Copyright
Copyright © Cambridge University Press 2010

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