Monetary Shocks in Bounded Efficient Financial Markets with Bounded Rational Agents

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Drescher, Christian ; Herz, Bernhard:
Monetary Shocks in Bounded Efficient Financial Markets with Bounded Rational Agents.
Bayreuth : Universität Bayreuth , 2012 . - 34 S. - (Wirtschaftswissenschaftliche Diskussionspapiere der Universität Bayreuth, Rechts- und Wirtschaftswissenschaftliche Fakultät ; 09-12 )

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Abstract

During the recent US financial crisis it became evident again how fast shocks can spread
in the financial system. Using the analytical framework of heterogeneous agent mod-
els, we analyze how monetary shocks are processed and dispersed across a network of
financial markets. We focus on micro shocks, triggered by changes in the market liq-
uidity, and macro shocks, caused by monetary policy decisions. Our model accounts for
bounded efficient financial markets producing market anomalies and bounded rational
agents, who derive their decisions based upon heuristics. Firstly, our model is able to
replicate key stylized facts of asset returns in financial markets. Secondly, the intensity
of shocks affects financial market stability by changing the investment strategies in asset
markets. Thirdly, we identify two mechanisms of contagion effects between asset mar-
kets. The substitution mechanism is triggered by changes in market-specific variables
and the sentiment mechanism is initiated by herding behavior. Fourthly, our analysis
shows that market efficiency in a specific asset market does not only depend upon the
condition of the particular asset market but also on the conditions of the other asset
markets.