Modeling the Interconnections between the Financial System and the Real Economy using the Principles of Statistical Mechanics

 Romanian version

Project type: CNCSIS PNII-RU-PD 583/2010, 2010-2012

Project team:

• Ciprian Necula, PhD

Abstract

The research project aims to conduct a deeper investigation of the interconnections between the financial system and the real economy, by developing, for the first time in the literature, a model that captures the insights of the theory of reflexivity about the influence of stock prices on fundamentals.

The motivation of the research project resides in the belief that the standard approach, based on the representative agent paradigm, is misguided, and that a fundamentally different approach, based on statistical physics, is necessary to analyze the interconnections between the financial system and the real economy.

The real economy and the financial markets are modeled as complex systems of interacting heterogeneous agents using tools drawn from statistical physics, mathematics, biology, economics and other social sciences. More specifically, we employ the stochastic dynamic aggregation techniques. Also the notion of equilibrium needs to be reconsidered.

The final objective of the research project consists in modeling the interconnections between the stock price and the fundamentals using the following the transmission mechanism: the stock prices affect the mood (i.e. confidence) of the economic agents, the mood of economic agents affect the aggregate level of consumption and investment, and, therefore, the aggregate level of output and the level of profit per share, which is the fundamental variable that influences the stock price. The model that will be developed in this research project will have a major impact on theoretical level and will have direct policy implications, providing decision-makers with refined instruments for analyzing the interconnections between fundamentals, the confidence of economic agents and the stock market.

Completed objectives

2010

• Building a modeling framework based on principles of statistical mechanics to analyze the interactions between different categories of heterogeneous economic agents

2011

• Building a framework for analyzing the interconnections between the financial system and real economy using stock-flow consistent models
• Modeling the dynamics of confidence

2012

• Modeling asset price dynamics in the context of the framework
• Modeling the interconnections between the asset price and fundamentals

Selected publications

• Necula C. and A-N Radu, (2012), Quantifying the recapitalization fund premium using option pricing techniques, Economics Letters, 114, 3, 249-251
• Necula C. (2012), A Framework for Analyzing the Reflexive Relationship Between Stock Prices and Fundamentals, Procedia - Social and Behavioral Sciences, 62, 377–381
• Necula, C. and A-N. Radu, (2012), Long Memory in Eastern European Financial Markets, Economic Research (Ekonomska istrazivanja), 25, 2, 361 - 378
• Necula C., (2010), Modeling the Dependency Structure of Stock Index Returns using a Copula Function Approach, Romanian Journal of Economic Forecasting, 13, 3, 96-106
• Necula C. and A-N Radu, (2012), The Dependency Structure of Stock Market Returns in Central and Eastern European Countries, in Socol C. (ed), Emerging macroeconomics. Case studies - Central and Eastern Europe, Nova Science, New York
• Necula C. and A-N Radu, (2011), The Distribution of EUR/RON Returns In A General Equilibrium Model With Jumps
• Radu A-N, C. Necula and A Trifan, (2011), The Dynamics of Bank Assets Volatility in Central and Eastern European Countries

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