Noemi Schmitt

Evolutionary competition and profit taxes: market stability versus tax burden

The seminal cobweb model by Brock and Hommes reveals that fixed-point dynamics may turn into increasingly complex dynamics as firms switch more quickly between competing expectation rules. While policy-makers may be able to manage such rational routes to randomness by imposing a proportional profit tax, the stability-ensuring tax rate may cause a very high tax burden for firms. Using a mix of analytical and numerical tools, we show that a rather small profit-dependent lump-sum tax may even be sufficient to take away the competitive edge of cheap destabilizing expectation rules, thereby contributing to market stability.

Herding behavior and volatility clustering in financial markets

We propose a financial market model in which speculators follow a linear mix of technical and fundamental trading rules to determine their orders. Volatility clustering arises in our model due to speculators’ herding behaviour. In case of heightened uncertainty, speculators observe other speculators’ actions more closely. Since speculators’ trading behaviour then becomes less heterogeneous, the market maker faces a less balanced excess demand and consequently adjusts prices more strongly. Estimating our model using the method of simulated moments reveals that it is able to explain a number of stylized facts of financial markets quite well. Various robustness checks with respect to the model setup reveal that our results are quite stable.

Market Interactions, Endogenous Dynamics and Stabilization Policies

We review a recent literature that shows that interactions between markets, created by the market entry and exit behavior of boundedly rational firms, may cause complex endogenous dynamics. In particular, these models predict that welfare decreases if firms rapidly switch between markets. Against this background, we show that policy makers have the opportunity to stabilize markets and thus to enhance welfare by regulating interacting markets. For instance, imposing profit taxes reduces the markets’ profit differentials and thus slows down the firms’ market entry and exit behavior. However, these stabilization policies may also lead to undesirable side effects, such as coexistence of attractors, hysteresis effects and, in a multi-region setting, failure of policy makers to coordinate on the globally optimal policy. Moreover, regulation may be subject to the lobbying efforts of special interest groups and thus not be optimal.