Firms in financial distress: evidence from inter-firm payment networks with volatility driven by ‘animal spirits’

Abstract

This paper elaborates an agent-based model of a pure market economy to provide theoretical evidence on how volatility-induced changes in inter-firm payment networks affect the financial distress of firms. This volatility is driven by ‘animal spirits’ in that it arises from the feelings of optimism/pessimism independently of rational decision-making, and influences the liquidity available to each firm through the inter-firm payment network; consequently, some firms may enter financial distress. The model first determines the inter-firm payment network. Then, a mean-reverting square-root process introduces volatility into the inter-firm payment network through firms’ propensity to pay suppliers according to the payments that firms expect to receive from customers. The model is calibrated for compatibility with relevant macro- and microeconomic stylized facts. According to computational experiments, financial distress in the business sector is minimized when feelings of optimism/pessimism generate the lowest volatility in firms’ propensity to pay suppliers. In addition, this volatility must materialize around an intermediate value of firms’ propensity to pay suppliers, and firms must keep this intermediate value over time.