Investment behaviour and “bull & bear” dynamics: modelling real and stock market interactions

Abstract

In this article, we develop a simple behavioural macrodynamic model in continuous-time with the purpose of investigating the interaction of the real economy and the financial markets. Building on Westerhoff (Discret Dyn Nat Soc, 2012), we improve the specification of aggregate demand by distinguishing between consumption and investment expenditure and assuming that the latter is determined by the flexible accelerator principle. We remove the ad hoc nonlinearity in the fundamentalist behavioural rule and allow the composition of the population between chartists and fundamentalists to be endogenously determined. The resulting nonlinear dynamic systems are shown to generate various dynamic regimes, among which the coexistence of periodic attractors with interesting economic implications. Endogenous investment and stock market dynamics emerge, procyclical to each other, reflecting the interaction of induced investment with alternating waves in speculators’ sentiments. We show that a strong investment accelerator might be a crucial force generating fluctuations that, on the one hand, are transmitted and amplified by chartists and, on the other hand, are contained by fundamentalists.