NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH
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Wenhao Li

E-Mail: EmailAddress: hidden: you can email any NBER-related person as first underscore last at nber dot org
Institutional Affiliation: University of Southern California

NBER Working Papers and Publications

May 2020Dissecting Mechanisms of Financial Crises: Intermediation and Sentiment
with Arvind Krishnamurthy: w27088
We develop a model of financial crises with both a financial amplification mechanism, via frictional intermediation, and a role for sentiment, via time-varying beliefs about an illiquidity state. We confront the model with data on credit spreads, equity prices, credit, and output across the financial crisis cycle. In particular, we ask the model to match data on the frothy pre-crisis behavior of asset markets and credit, the sharp transition to a crisis where asset values fall, disintermediation occurs and output falls, and the post-crisis period characterized by a slow recovery in output. We find that a pure amplification mechanism quantitatively matches the crisis and aftermath period but fails to match the pre-crisis evidence. Mixing sentiment and amplification allows the model to addit...
 
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