Macro, Money and Finance: A Continuous Time Approach
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.
This article was written for the Handbook of Macroeconomics. We are grateful to comments by various participants of the Princeton Initiative: Macro, Money and Finance, and especially to Zhiguo He, Lunyang Huang, Ji Huang, Falk Mazelis, Sebastian Merkel, Greg Phelan, and Christian Wolf, as well as to the editors John Taylor and Harald Uhlig. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
Markus K. Brunnermeier
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Swiss Finance Institute, 2012-
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Sloan Foundation 2011-12
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