A Macroeconomic Model with a Financial Sector
Publication Year
2014
Type
Journal Article
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.
Keywords
Journal
American Economic Review
Volume
104
Pages
379–421
Date Published
feb
ISSN Number
0002-8282
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