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How Market Intervention can Prevent Bubbles and Crashes: An Agent Based Modelling Approach

Author

Listed:
  • Rebecca Westphal

    (ETH Zürich)

  • Didier Sornette

    (ETH Zürich
    Southern University of Science and Technology
    Tokyo Institute of Technology)

Abstract

Using a previously validated agent-based model with fundamentalists and chartists, we investigate the usefulness and impact of direct market intervention. The policy maker diagnoses bubbles by forming an expectation of the future returns, then invests in burgeoning bubbles to develop a sufficient inventory of the risky asset in order to be able to sell adequate amounts of the overpriced asset later countercyclically to fight market exuberance. Preventing bubbles and crashes, this market intervention improves all analysed market return metrics, volatility, skewness, kurtosis and VaR, without affecting long-term growth. This increases the Sharpe ratios of noise traders and of fundamentalists by approximately 28% and 45% respectively. The results are robust even for substantially miscalibrated long-term expected returns.

Suggested Citation

  • Rebecca Westphal & Didier Sornette, 2024. "How Market Intervention can Prevent Bubbles and Crashes: An Agent Based Modelling Approach," Computational Economics, Springer;Society for Computational Economics, vol. 64(3), pages 1315-1356, September.
    • Handle: RePEc:kap:compec:v:64:y:2024:i:3:d:10.1007_s10614-023-10462-8
    DOI: 10.1007/s10614-023-10462-8
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    More about this item

    Keywords

    Financial bubbles; Agent-based model; Arbitrageurs; Prediction; Noise traders; Fundamentalists; Market intervention;
    All these keywords.

    JEL classification:

    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General
    • G01 - Financial Economics - - General - - - Financial Crises
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation

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