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A Macroeconomic Model with a Financial Sector

  • Markus K. Brunnermeier
  • Yuliy Sannikov

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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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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  1. Lars Ljungqvist & Thomas J. Sargent, 2004. "Recursive Macroeconomic Theory, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 026212274x, December.
  2. Shin, Hyun Song, 2010. "Risk and Liquidity," OUP Catalogue, Oxford University Press, number 9780199546367, December.
  3. Yuliy Sannikov, 2008. "A Continuous-Time Version of the Principal-Agent Problem," Review of Economic Studies, Oxford University Press, vol. 75(3), pages 957-984.
  4. Kindleberger, Charles P., 1993. "A Financial History of Western Europe," OUP Catalogue, Oxford University Press, edition 2, number 9780195077384, December.
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