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A Macroeconomic Framework for Quantifying Systemic Risk

52 Pages Posted: 21 Aug 2012 Last revised: 17 Apr 2015

Zhiguo He

University of Chicago - Booth School of Business, and NBER

Arvind Krishnamurthy

Northwestern University - Kellogg School of Management

Multiple version iconThere are 3 versions of this paper

Date Written: June 2, 2014

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: Liquidity, Delegation, Financial Intermediation, Crises, Financial Friction, Constraints

JEL Classification: G12, G2, E44

Suggested Citation

He, Zhiguo and Krishnamurthy, Arvind, A Macroeconomic Framework for Quantifying Systemic Risk (June 2, 2014). Fama-Miller Working Paper; Swiss Finance Institute Research Paper No. 13-42; Chicago Booth Research Paper No. 12-37. Available at SSRN: https://ssrn.com/abstract=2133412 or http://dx.doi.org/10.2139/ssrn.2133412

Zhiguo He (Contact Author)

University of Chicago - Booth School of Business, and NBER ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

HOME PAGE: http://faculty.chicagobooth.edu/zhiguo.he/pubs.html

Arvind Krishnamurthy

Northwestern University - Kellogg School of Management ( email )

2001 Sheridan Road
Evanston, IL 60208
United States
847-491-2671 (Phone)
847-491-5719 (Fax)

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