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A Macroeconomic Model with a Financial Sector

Author Info

Listed author(s):
  • Yuliy Sannikov
  • Markus K. Brunnermeier

    (Princeton University)

Abstract

This paper studies a macroeconomic model in which financial experts borrow from less productive agents in order to invest in financial assets. We pursue three set of results: (i) Going beyond a steady state analysis, we show that adverse shocks cause amplifying price declines not only through the erosion of net worth of the financial sector, but also through increased price volatility, leading to precautionary hoarding and fire sales. (ii) Financial sector’s leverage and maturity mismatch is excessive, since it does not internalize externalities it imposes on the labor sector and other financial experts due to a fire-sale externality. (iii) Securitization, which allows the financial sector to offload some risk, exacerbates the excessive risk-taking.

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Paper provided by Society for Economic Dynamics in its series 2010 Meeting Papers with number 1114.

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Date of creation: 2010
Handle: RePEc:red:sed010:1114
Contact details of provider: Postal:
Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

Web page: http://www.EconomicDynamics.org/
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Find related papers by JEL classification:
  • E13 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Neoclassical
  • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
  • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
  • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
  • G01 - Financial Economics - - General - - - Financial Crises
  • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
  • G20 - Financial Economics - - Financial Institutions and Services - - - General

References listed on IDEAS
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  1. Fudenberg, Drew & Holmstrom, Bengt & Milgrom, Paul, 1990. "Short-term contracts and long-term agency relationships," Journal of Economic Theory, Elsevier, vol. 51(1), pages 1-31, June.
  2. Markus K. Brunnermeier & Lasse Heje Pedersen, 2009. "Market Liquidity and Funding Liquidity," Review of Financial Studies, Society for Financial Studies, vol. 22(6), pages 2201-2238, June.
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  7. Lars Ljungqvist & Thomas J. Sargent, 2004. "Recursive Macroeconomic Theory, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 026212274x, July.
  8. Lawrence J. Christiano & Roberto Motto & Massimo Rostagno, 2003. "The Great Depression and the Friedman-Schwartz hypothesis," Proceedings, Federal Reserve Bank of Cleveland, pages 1119-1215.
  9. Olivier Jeanne & Anton Korinek, 2010. "Managing Credit Booms and Busts: A Pigouvian Taxation Approach," NBER Working Papers 16377, National Bureau of Economic Research, Inc.
  10. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
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  13. Kindleberger, Charles P., 1993. "A Financial History of Western Europe," OUP Catalogue, Oxford University Press, edition 2, number 9780195077384.
  14. Joost Driessen & Pascal J. Maenhout & Grigory Vilkov, 2009. "The Price of Correlation Risk: Evidence from Equity Options," Journal of Finance, American Finance Association, vol. 64(3), pages 1377-1406, 06.
  15. Bernanke, Ben & Gertler, Mark, 1989. "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, American Economic Association, vol. 79(1), pages 14-31, March.
  16. Vasco Curdia & Michael Woodford, 2010. "Credit Spreads and Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(s1), pages 3-35, 09.
  17. 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.
  18. PETER M. DeMARZO & YULIY SANNIKOV, 2006. "Optimal Security Design and Dynamic Capital Structure in a Continuous-Time Agency Model," Journal of Finance, American Finance Association, vol. 61(6), pages 2681-2724, December.
  19. Townsend, Robert M., 1979. "Optimal contracts and competitive markets with costly state verification," Journal of Economic Theory, Elsevier, vol. 21(2), pages 265-293, October.
  20. Shin, Hyun Song, 2010. "Risk and Liquidity," OUP Catalogue, Oxford University Press, number 9780199546367.
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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
  3. Macroeconomic Modeling of Financial Frictions for Macroprudential Policymaking: A Review of Pressing Challenges
    by thebusinesscycleblog in The business cycle blog on 2016-06-05 18:18:07
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