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A Macroeconomic Model with a Financial Sector

  • Yuliy Sannikov

    (Princeton University)

  • Markus Brunnermeier

    (Princeton University)

This paper studies the full equilibrium dynamics of an economy with financial frictions. Due to highly non-linear amplication effects, the economy is prone to instability and occasionally enters volatile episodes. Risk is endogenous and asset price correlations are high in downturns. In an environment of low exogenous risk experts assume higher leverage making the system more prone to systemic volatility spikes - a volatility paradox. Securitization and derivatives contracts leads to better sharing of exogenous risk but to higher endogenous systemic risk. Financial experts may impose a negative externality on each other by not maintaining adequate capital cushion.

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Paper provided by Society for Economic Dynamics in its series 2012 Meeting Papers with number 507.

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Date of creation: 2012
Date of revision:
Handle: RePEc:red:sed012:507
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Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

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  1. 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.
  2. Shin, Hyun Song, 2010. "Risk and Liquidity," OUP Catalogue, Oxford University Press, number 9780199546367, December.
  3. Kindleberger, Charles P., 1993. "A Financial History of Western Europe," OUP Catalogue, Oxford University Press, edition 2, number 9780195077384, December.
  4. Lars Ljungqvist & Thomas J. Sargent, 2004. "Recursive Macroeconomic Theory, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 026212274x, December.
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