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

Rebecca Westphal () and Didier Sornette ()
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Rebecca Westphal: ETH Zürich
Didier Sornette: ETH Zürich

Computational Economics, 2024, vol. 64, issue 3, No 1, 1315-1356

Abstract: 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.

Keywords: Financial bubbles; Agent-based model; Arbitrageurs; Prediction; Noise traders; Fundamentalists; Market intervention (search for similar items in EconPapers)
JEL-codes: C53 C63 E58 E60 G01 G17 G18 (search for similar items in EconPapers)
Date: 2024
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DOI: 10.1007/s10614-023-10462-8

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