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A Macroeconomic Model with a Financial Sector

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  • Markus K. Brunnermeier
  • Yuliy Sannikov
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    Abstract

    This article studies the full equilibrium dynamics of an economy with financial frictions. Due to highly nonlinear amplification effects, the economy is prone to instability and occasionally enters volatile crisis episodes. Endogenous risk, driven by asset illiquidity, persists in crisis even for very low levels of exogenous risk. This phenomenon, which we call the volatility paradox, resolves the Kocherlakota (2000) critique. Endogenous leverage determines the distance to crisis. Securitization and derivatives contracts that improve risk sharing may lead to higher leverage and more frequent crises.

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    Bibliographic Info

    Article provided by American Economic Association in its journal American Economic Review.

    Volume (Year): 104 (2014)
    Issue (Month): 2 (February)
    Pages: 379-421

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    Handle: RePEc:aea:aecrev:v:104:y:2014:i:2:p:379-421

    Note: DOI: 10.1257/aer.104.2.379
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    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. YELLEN: Monetary Policy Shouldn't Change Because People Are Worried About Financial Stability
      by Rob Wile in Business Insider on 2014-07-02 15:00:00
    2. Chair Janet L. Yellen: Monetary Policy and Financial Stability
      by Guest Author in The Big Picture on 2014-07-03 09:00:18
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    Cited by:
    1. Thorsten Beck & Andrea Colciago & Damjan Pfajfar, 2014. "The role of financial intermediaries in monetary policy transmission," DNB Working Papers 420, Netherlands Central Bank, Research Department.
    2. Josef Falkinger, 2014. "In search of economic reality under the veil of financial markets," ECON - Working Papers 154, Department of Economics - University of Zurich.

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