Fear and Financial Contagion: Modeling Animal Spirits in Asset Markets

Francesco Renzini and Joshua M. Epstein

No rqxhm_v1, SocArXiv from Center for Open Science

Abstract: Using classic equations from cognitive neuroscience, we introduce fear into a model of trading behavior. Fear is modeled as an agent-level state variable with its own autonomic dynamics. Using this framework, we show that financial contagion can emerge as a byproduct of fear-driven responses, by fundamental investors, to negative news. Employing Bayesian model selection techniques, we show that incorporating these dynamic animal spirits substantially improves the model’s fit to real market data relative to standard formulations that exclude fear. Our model also clarifies how fear-driven behavior within one group of investors propagates throughout the market ecosystem via endogenous price feedback.

Date: 2026-06-19
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Persistent link: https://EconPapers.repec.org/RePEc:osf:socarx:rqxhm_v1

DOI: 10.31219/osf.io/rqxhm_v1

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