Financial Stability Implications of Generative AI: Taming the Animal Spirits

Abstract: This paper investigates the impact of the adoption of generative AI on financial stability. We conduct laboratory-style experiments using LLMs to replicate classic studies on herd behavior in trading decisions. Our results show that AI agents make more rational decisions than humans, relying predominantly on private information over market trends. Increased reliance on AI-powered trading advice could therefore potentially lead to fewer asset price bubbles arising from animal spirits that trade by following the herd. However, exploring variations in the experimental settings reveals that AI agents can be induced to herd optimally when explicitly guided to make profit-maximizing decisions. While optimal herding improves market discipline, this behavior still carries potential implications for financial stability. In other experimental variations, we show that AI agents are not purely algorithmic, but have inherited some elements of human conditioning and bias.