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A Macroeconomic Model with a Financial Sector

Listed author(s):
  • 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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File URL: https://economicdynamics.org/meetpapers/2012/paper_507.pdf
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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
Handle: RePEc:red:sed012:507
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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