Working Paper: NBER ID: w22343
Authors: Markus K. Brunnermeier; Yuliy Sannikov
Abstract: This paper puts forward a teaching manual for how to set up and solve a continuous time model that allows one to analyze endogenous (1) level and risk dynamics. The latter includes (2) tail risk and crisis probability as well as (3) the Volatility Paradox. Concepts such as (4) illiquidity and liquidity mismatch, (5) endogenous leverage, (6) the Paradox of Prudence, (7) undercapitalized sectors (8) time-varying risk premia, and (9) the external funding premium are part of the analysis. Financial frictions also give rise to an endogenous (10) value of money.
Keywords: continuous time models; financial frictions; risk dynamics; macro finance
JEL Codes: C63; E32; E41; E44; E51; G01; G11; G20
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Financial frictions (G19) | economic crises (G01) |
| endogenous risk dynamics (D80) | consumption decisions (D12) |
| endogenous risk dynamics (D80) | investment decisions (G11) |
| temporary macro shocks (E39) | economic activity (E20) |
| risk-taking behaviors (D91) | economic instability (E32) |