Propagation of Financial Crises: A Heterogenous Agents Approach

We propose a two-market heterogeneous agents model with coupling mechanism to study Financial crisis with contagion effect. It manages to calibrate sudden crash behavior of US and UK stock markets during "Black Monday" of 1987 besides smooth crisis and disturbing crisis categorized in literature. It is implied that financial crisis and its contagion could be endogenous and supports scenario of over-valuation causing financial crisis. In addition, the model shows that financial system could be fragile in which small shock(s) hitting individual market's fundamental could cause financial crisis which spreads to other market. It also supports scenario of external shock triggering financial crisis. Lastly, the model manages to match typical stylized facts, especially cross-correlation which is exclusive to multi-market case.