Contagion between asset markets: A two market heterogeneous agents model with destabilising spillover effects

This paper investigates a two market heterogeneous agents model with biased trend followers and fundamentalists. The two separate and identically modelled markets are mutually dependent only through the introduced bias of the chartists’ belief and co-evolve over time. The bias term depends on the state of the other market. Agents update their prediction rules for tomorrow's price according to their relative past performance as in Brock and Hommes (1997,1998). Using both analytical and numerical methods we find that the bias may have destabilising spillover effects between two otherwise stable markets, leading to irregular and unpredictable price dynamics with bubbles and crashes, as the the intensity of choice to switch prediction rules becomes high. Our behavioural model provides a simple and intuitive explanation of co-movements in asset markets.