Agents' beliefs and economic regimes polarization in interacting markets

TL;DR

This paper models interacting real and financial markets with biased agents whose beliefs influence economic stability, showing how polarization can lead to multiple steady states, complex dynamics, and market phenomena like bubbles and crashes.

Contribution

It introduces a model linking belief polarization to multiple steady states and complex dynamics in an interacting market framework, incorporating stochastic effects.

Findings

Polarized beliefs can create multiple stable income levels.

Belief relevance influences the degree of polarization and market outcomes.

Model reproduces stylized facts like fat tails, volatility, bubbles, and crashes.

Abstract

In the present paper a model of a market consisting of real and financial interacting sectors is studied. Agents populating the stock market are assumed to be not able to observe the true underlying fundamental, and their beliefs are biased by either optimism or pessimism. Depending on the relevance they give to beliefs, they select the best performing strategy in an evolutionary perspective. The real side of the economy is described within a multiplier-accelerator framework with a nonlinear, bounded investment function. We show that strongly polarized beliefs in an evolutionary framework can introduce multiplicity of steady states, which, consisting in enhanced or depressed levels of income, reflect and reproduce the optimistic or pessimistic nature of the agents' beliefs. The polarization of these steady states, which coexist with an unbiased steady state, positively depends on that of the beliefs and on their relevance. Moreover, with a mixture of analytical and numerical tools, we show that such static characterization is inherited also at the dynamical level, with possibly complex attractors that are characterized by endogenously fluctuating pessimistic and optimistic levels of national income and price. This framework, when stochastic perturbations are included, is able to account for stylized facts commonly observed in real financial markets, such as fat tails and excess volatility in the returns distributions, as well as bubbles and crashes for stock prices.