A Macroeconomic Model with a Financial Sector
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.
|Date of creation:||2012|
|Date of revision:|
|Contact details of provider:|| Postal: Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA|
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- 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.
- Shin, Hyun Song, 2010. "Risk and Liquidity," OUP Catalogue, Oxford University Press, number 9780199546367, December.
- Kindleberger, Charles P., 1993. "A Financial History of Western Europe," OUP Catalogue, Oxford University Press, edition 2, number 9780195077384, December.
- 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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