Financial instability and debt deflation dynamics in a bottom-up approach

In this paper we expand the agent based model introduced by Chiarella and Di Guilmi (Chiarella, C. and Di Guilmi, C., The financial instability hypothesis: A stochastic microfoundation framework. Journal of Economic Dynamics and Control, 35(8):1151 – 1171, 2011) in which the business cycle originates by the modifications in firms' balance sheets induced by their investment decisions. During periods of market euphoria, firms increase their capital stock and their level of debt. At the same time the increasing availability of liquidity for investors causes inflation in asset price. When firms' debt reaches an unsustainable level the virtuous cycle is reversed in a depression. We modify the original model in order to study the impact of the dependence of firms' expectations on the stock market performance and of the rise in the proportion of Ponzi firms. We also run a further computational experiment to assess the effect of the buy-back of firms' shares.