Working Paper: NBER ID: w19885
Authors: Zhiguo He; Arvind Krishnamurthy
Abstract: Systemic risk arises when shocks lead to states where a disruption in financial intermediation adversely affects the economy and feeds back into further disrupting financial intermediation. We present a macroeconomic model with a financial intermediary sector subject to an equity capital constraint. The novel aspect of our analysis is that the model produces a stochastic steady state distribution for the economy, in which only some of the states correspond to systemic risk states. The model allows us to examine the transition from "normal" states to systemic risk states. We calibrate our model and use it to match the systemic risk apparent during the 2007/2008 financial crisis. We also use the model to compute the conditional probabilities of arriving at a systemic risk state, such as 2007/2008. Finally, we show how the model can be used to conduct a macroeconomic "stress test" linking a stress scenario to the probability of systemic risk states.
Keywords: systemic risk; financial intermediation; macroeconomic model
JEL Codes: E44; G01; G2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| disruptions in financial intermediation (F65) | economic crisis (G01) |
| binding of equity capital constraints in the intermediary sector (F65) | systemic risk (E44) |
| negative shocks to the intermediary sector (F65) | declines in equity and investment (G12) |
| anticipated constraints (D10) | influence on asset prices and investment decisions (G11) |
| financial intermediary dynamics (G21) | systemic risk (E44) |