Working Paper: NBER ID: w15110
Authors: Paul Beaudry; Amartya Lahiri
Abstract: In this paper we discuss how several macroeconomic features of the 2001-2009 period may have resulted from a process in which financial markets were trying to allocate risk between heterogeneous agents when productive investment opportunities are scarce. We begin by showing how heterogeneity in terms of risk tolerance can cause financial markets to propagate transitory shocks and induce higher output volatility, albeit with a higher mean. We then show how this simple heterogeneous agent framework can explain an expansion driven by the growth in consumer debt, and why the equilibrium path of such an economy is likely fragile. In particular, we demonstrate that the emergence of a small amount of asymmetric information can make the economy susceptible to changes in expectations that can induce large reversals of financial flows, the freezing of assets and a recession that can persist despite high productivity.
Keywords: Risk Allocation; Debt; Financial Crisis; Heterogeneous Agents
JEL Codes: E3; E4; G01
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| increased risk capital (G31) | increased employment (J68) |
| increased risk capital (G31) | lower risk premia (G19) |
| high profitability (L21) | increased risk capital (G31) |
| increased risk capital (G31) | economic expansions (E32) |
| asymmetric information (D82) | increased risk premia (G19) |
| increased risk premia (G19) | economic contractions (E32) |
| high profitability (L21) | lower risk premia (G19) |
| high profitability (L21) | increased employment (J68) |
| increased risk capital (G31) | increased output volatility (E32) |
| risk allocation processes (G22) | increased output volatility (E32) |