Abstract

I develop a two market agent-based model to study how global portfolio managers affect global financial crises and stability. The Markowitz model is extended by incorporating several insights from behavioral finance. Simulation results of an agent-based version of the Markowitz model reveal that global financial crises do not occur when global managers are added to the model. However, when risk is determined based on investors ’ historical losses and exponential averaging, slight global manager losses can trigger a widening of both markets ’ risk premium, accelerating the decline in asset prices worldwide. Statistical analysis reveals that global managers are a stabilizing force in smaller numbers; however, they become destabilizing in larger numbers. The ability to reduce risk by diversifying across markets results in excessive risk taking. If global managers exist in larger numbers, systematic over leverage may result such that a deleveraging process can lead to the spreading of financial crises. Other results indicate the existence of contagion and the importance of the real linkage versus the global manager linkage depends on the amount of total assets global managers control in each market. ∗I am grateful Dan Friedman for invaluable advice. I retain sole responsibility for remaining idiosyncrasies and errors.

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