What is the drawback of focusing on a particular part of the state space?

focusing on a particular part of the state space through changes of an exogenous parameter φ also has serious drawbacks, as it completely changes system dynamics.

Why is the economy less likely to get stuck near = 0.?

because risk-averse experts are more cautious than risk-neutral experts, they use less leverage and the economy is less likely to get stuck near η = 0.Correlation in Asset Prices and “Fat Tails.”

What is the effective way to increase risk-taking incentives in a crisis?

Policies for crisis episodes alone, such as those aimed at recapitalizing the financial system, can increase risk-taking incentives ex-ante.

Why does a decline in cash flow volatility encourage experts to increase their leverage?

The reason is that a decline in cash flow volatility encourages experts to increase their leverage by reducing their net worth buffer.

What is the effect of a policy that forces experts to retain more net worth?

As experts are forced to retain more net worth, the price of capital rises, and even becomes greater than q̄ at the steady state.

What does the equilibrium change with borrowing frictions eliminated?

With borrowing frictions eliminated, the laws of motion of ηt and functions q(η), θ(η) and ψ(η) are the same as in the baseline setting with Λ(x) = 0. Contracts on aggregate risk among expert do not change the equilibrium, as they do not alter the total aggregate risk exposure of the expert sector.

What is the reason why the observed option price patterns arise in their setting?

The observed option price patterns arise quite naturally in their setting as the correlation across stock prices increases in crisis times.

What is the general framework for studying default in their setting?

More generally, an equivalent capital structure involving risky long-term debt provides an important framework for studying default in their setting.

What is the definition of a constrained-feasible policy?

A symmetric constrained-feasible policy is described by a group of stochastic processes on the filtered probability space defined by the Brownian motion {Zt, t ≥ 0}: the price process qt, investment rates ιt and ιt, capital allocations ψtKt and (1−ψt)Kt, consumptions dCt and dCt, and transfers dτt such that(i) representative expert net worth dNt = dτt +

what is the way to calculate q′()?

From that point, the authors can use equations (23), (25) and (26) to compute q′(η) from η and q(η), and solve a first-order ordinary differential equation for q(η) until the point ηψ where ψt reaches 1.

What is the optimal strategy for a nt expert?

Then ntθt represents the maximal future expected payoff that an expert with net worth nt can attain and {xt, dζt} is an optimal strategy if and only if(i) θt ≥ 1 at all times, and dζt > 0 only when θt = 1,(ii) µθt =

What is the way to explain the difference between equity injection and asset purchasing?

He and Krishnamurthy (2010a) calibrate a variant of the model and show that in crisis equity injection is a superior policy compared to interest rate cuts or asset purchasing programs by the central bank.

Open AccessJournal Article10.2139/SSRN.2160894

A Macroeconomic Model with a Financial Sector

Markus K. Brunnermeier, +1 more

- 08 Apr 2012

- Social Science Research Network

273

TL;DR: In this paper, the authors studied the full equilibrium dynamics of an economy with financial frictions and found that risk is endogenous and asset price correlations are high in down turns, making the system more prone to systemic volatility spikes.

Abstract: This paper studies the full equilibrium dynamics of an economy with financial frictions. Due to highly non-linear amplification effects, the economy is prone to instability and occasionally enters volatile episodes. Risk is endogenous and asset price correlations are high in down turns. 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 and the economy by not maintaining adequate capital cushion.

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Most frequently asked questions

1. What have the authors contributed in "A macroeconomic model with a financial sector" ?

This paper studies the full equilibrium dynamics of an economy with financial frictions.

2. What is the effect of amplification through prices?

The amplification through prices works through adverse feedback loops, as declining net worth of levered agents leads to drop in prices of assets concentrated in their hands, further lowering these agents’ net worth.

3. Why is the wealth of experts important for their ability to buy physical capital?

Because of financial frictions, the wealth of experts is important for their ability to buy physical capital and use it productively.

4. What is the paradox of amplification loops in crisis regimes?

As aggregate risk goes down, equilibrium leverage goes up, and amplification loops in crisis regimes become more severe - a volatility paradox.

Figure 2: The drift and volatility of ηt, expert leverage, and expected asset returns.

Figure 7: Equilibrium with σ = 10% and Λ(x) = ξ(x− 1), ξ = 0, .01 and .02.

Figure 4: Systemic risk: total volatility of capital and the stationary density of ηt.

Figure 6: Equilibrium for three levels of exogenous risk, σ = 50%, 20% and 5%.

Figure 8: Equilibrium without and with restrictions on payouts.

Citations

•Journal Article•10.1111/J.1467-6419.2012.00729.X

Macroprudential policy – a literature review

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- 11 May 2012

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TL;DR: The recent financial crisis has highlighted the need to go beyond a purely micro approach to financial regulation and supervision and the number of policy speeches, research papers and conferences that discuss a macro perspective on financial regulation has grown considerably.

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The financial cycle and macroeconomics: What have we learnt?

Claudio Borio

- 01 Aug 2014

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TL;DR: The authors highlights the stylised empirical features of the financial cycle, conjectures as to what it may take to model it satisfactorily, and considers its policy implications, and pays special attention to the bust phase.

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Fire Sales in Finance and Macroeconomics

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- 01 Feb 2011

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TL;DR: A review of the literature on fire sales in financial markets can be found in this paper, where the authors focus on the role of asset "fire sales" in depleting the balance sheets of financial institutions and aggravating the fragility of the financial system.

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Andrei Shleifer, +3 more

- 01 Dec 2010

- Social Science Research Network

TL;DR: In this paper, the authors overview theoretical and empirical research on asset fire sales, which shows how they can arise, how they lead to asset under-valuations, how contracts and bankruptcy regimes adjust to the risk of fire sales and how fire sales can lead to downward spirals or cascades in asset prices.

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- 01 Jun 2015

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References

•Book•10.1596/1813-9450-5160

The Margins of Labor Cost Adjustment : Survey Evidence from European Firms

Jan Babecky, +5 more

- 06 Jan 2010

- Social Science Research Network

TL;DR: In this paper, the authors find that firms make frequent use of other, more flexible, components of compensation to adjust the cost of labor, such as bonuses and non-pay benefits.

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Temporal Distribution of Price Changes: Staggering in the Large and Synchronization in the Small. *

Emmanuel Dhyne, +1 more

- 28 Jun 2007

- Social Science Research Network

TL;DR: In this article, the authors use a large Belgian data set to analyze whether price changes are staggered or synchronized. And they find that the more aggregated are the data, the closer is the distribution to perfect staggering.

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Investment-specific techonology shocks and labor market frictions

Reinout De Bock

- 01 Feb 2007

- Social Science Research Network

TL;DR: In this article, the implications of technical progress through investment-specific technical change in a business cycle model with search and matching frictions and endogenous job destruction were studied, showing that the interaction between the capital formation needed to reap the benefits of an investment specific technology shock and gradual labor-market matching, generates hump-shaped, persistent responses in output, vacancies, and unemployment.

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Economic Importance of the Belgian Ports: Flemish Maritime Ports and Liège Port Complex - Report 2004

Frédéric Lagneaux

- 28 Jun 2006

- Social Science Research Network

TL;DR: In this article, the authors present an overview of the economic importance and development of the Flemish maritime ports together with the Liege port complex in 2004, focusing on the three major variables of value added, employment and investment, also providing some information about the financial situation of several vital sectors in each port.

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Trade, Wages, and Productivity

Kristian Behrens, +3 more

- 01 Jul 2009

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TL;DR: In this article, a general equilibrium model of monopolistic competition with heterogeneous firms, variable demand elasticity and multiple asymmetric regions was developed, in which trade integration induces wage and productivity changes.

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A Macroeconomic Model with a Financial Sector

Chat with Paper

AI Agents for this Paper

Most frequently asked questions

1. What have the authors contributed in "A macroeconomic model with a financial sector" ?

2. What is the effect of amplification through prices?

3. Why is the wealth of experts important for their ability to buy physical capital?

4. What is the paradox of amplification loops in crisis regimes?

5. What is the drawback of focusing on a particular part of the state space?

6. Why is the economy less likely to get stuck near = 0.?

7. What is the effective way to increase risk-taking incentives in a crisis?

8. Why does a decline in cash flow volatility encourage experts to increase their leverage?

9. What is the effect of a policy that forces experts to retain more net worth?

10. What does the equilibrium change with borrowing frictions eliminated?

11. What is the reason why the observed option price patterns arise in their setting?

12. What is the general framework for studying default in their setting?

13. What is the definition of a constrained-feasible policy?

14. what is the way to calculate q′()?

15. What is the optimal strategy for a nt expert?

16. What is the way to explain the difference between equity injection and asset purchasing?

Figures

Citations

Macroprudential policy – a literature review

The financial cycle and macroeconomics: What have we learnt?

Fire Sales in Finance and Macroeconomics

Fire Sales in Finance and Macroeconomics

Curbing the Credit Cycle

References

The Margins of Labor Cost Adjustment : Survey Evidence from European Firms

Temporal Distribution of Price Changes: Staggering in the Large and Synchronization in the Small. *

Investment-specific techonology shocks and labor market frictions

Economic Importance of the Belgian Ports: Flemish Maritime Ports and Liège Port Complex - Report 2004

Trade, Wages, and Productivity

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