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A Macroeconomic Model with a Financial Sector

Author(s): Brunnermeier, Markus K.; Sannikov, Yuliy

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Abstract: 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.
Publication Date: Feb-2014
Citation: Brunnermeier, Markus K., Sannikov, Yuliy. (2014). A Macroeconomic Model with a Financial Sector. American Economic Review, 104 (379 - 421). doi:10.1257/aer.104.2.379
DOI: doi:10.1257/aer.104.2.379
Pages: 379 - 421
Type of Material: Journal Article
Journal/Proceeding Title: American Economic Review
Version: Final published version. Article is made available in OAR by the publisher's permission or policy.

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