A Macroeconomic Model with a Financial Sector

TitleA Macroeconomic Model with a Financial Sector
Publication TypeJournal Article
Year of Publication2014
AuthorsBrunnermeier MK, Sannikov Y
JournalAmerican Economic Review
Date Publishedfeb
KeywordsAsset Pricing, Bond Interest Rates, Business Fluctuations, Cycles, Financial Crises, Financial Institutions and Services: General, Financial Markets and the Macroeconomy, General Aggregative Models: Neoclassical, Monetary Policy, Trading Volume
AbstractThis 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.