Can endogenous participation explain price volatility? Evidence from an agent-based cobweb model.

The cobweb model literature has mostly overlooked the issue of firms' financial viability and the related question of market entry and exit. This paper tries to address these problems building an agent-based computational cobweb model with borrowing constraints and endogenous participation of heterogeneous firms. The flow of firms' profit affects their financial wealth and borrowing is possible up to a limit. Past such threshold the firm goes bankrupt and exits. At the same time at each period a pool of potential entrants have a constant positive probability of becoming a startup in the market, provided the incumbent firms have realized non-negative mean profits in recent periods. Bounded dynamics and endogenous volatility are shown to follow without resorting to nonlinearities. Indeed, with respect to the literature assuming nonlinearities and heterogeneous firms switching between different predictors (e.g. Brock and Hommes, 1997) our structure is simpler, given that the model's main message remains valid even with linear demand and supply and firms having heterogeneous-parameters adaptive expectations. Additional insights are provided by the numerical simulations of the model. The saliency of the borrowing constraint has a large impact on profits and ultimately on firms' survival chances, beside an effect on average prices and therefore on consumer surplus. Further, the model confirms that behavioral heterogeneity, even in the mild form assumed here, matters, and is in fact crucial to ensure bounded price dynamics. Finally, the model generates reasonable (given the stylized facts accepted by the empirical literature) patterns of firms survival times.