Impact Analysis of Financial Regulation on Multi-Asset Markets Using Artificial Market Simulations

Masanori Hirano,Kiyoshi Izumi,Hiroyasu Matsushima,Takashi Shimada,Hiroki Sakaji

doi:10.3390/jrfm13040075

Masanori Hirano, Kiyoshi Izumi + Show 3 more

Open Access

https://doi.org/10.3390/jrfm13040075

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Abstract

In this study, we assessed the impact of capital adequacy ratio (CAR) regulation in the Basel regulatory framework. This regulation was established to make the banking network robust. However, a previous work argued that CAR regulation has a destabilization effect on financial markets. To assess impacts such as destabilizing effects, we conducted simulations of an artificial market, one of the computer simulations imitating real financial markets. In the simulation, we proposed and used a new model with continuous double auction markets, stylized trading agents, and two kinds of portfolio trading agents. Both portfolio trading agents had trading strategies incorporating Markowitz’s portfolio optimization. Additionally, one type of portfolio trading agent was under regulation. From the simulations, we found that portfolio optimization as each trader’s strategy stabilizes markets, and CAR regulation destabilizes markets in various aspects. These results show that CAR regulation can have negative effects on asset markets. As future work, we should confirm these effects empirically and consider how to balance between both positive and negative aspects of CAR regulation.

Highlights

The recent complexity of financial technology has increased the risk of financial markets, especially systemic risks
Before we present the results of each type of experiment we mentioned above, we show the results for checking whether stylized facts are appearing in our simulation
When the percentage of portfolio trading agents regulated by Basel is 100%, the difference in NDV between the instances of one market and ten markets is smaller than when the percentage is 0%. It suggested that capital adequacy ratio (CAR) regulation can suppress the stabilizing effect of portfolio trading agents. These results show that CAR regulation may destabilize markets even if there are multiple markets and portfolio trading agents have great stabilizing effects on markets

Summary

Introduction

The recent complexity of financial technology has increased the risk of financial markets, especially systemic risks. A systemic risk comes from the interaction between various components in financial markets. Systemic risk is one of the most significant dangers in financial markets because small triggers cause huge shocks in financial markets with the existence of systemic risks. One famous example of systemic risk is the financial crisis of 2007–2008. The crisis began with a local default of American subprime mortgage loans. The fails in subprime mortgages spread widely, and it affected stock markets. It affected American financial markets and global financial markets

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