Endogenous Risk in a DSGE Model with Capital-Constrained Financial Intermediaries

National Bank of Belgium Working Paper No. 235

63 Pages Posted: 14 Oct 2012

See all articles by Hans Dewachter

Hans Dewachter

Catholic University of Leuven (KUL) - Department of Economics; Erasmus Research Institute of Management (ERIM)

Rafael Wouters

National Bank of Belgium

Date Written: September 2012

Abstract

This paper proposes a perturbation-based approach to implement the idea of endogenous financial risk in a standard DSGE macro-model. Recent papers, such as Mendoza (2010), Brunnermeier and Sannikov (2012) and He and Krishnamurthy (2012), that have stimulated the research field on endogenous risk in a macroeconomic context, are based on sophisticated solution methods that are not easily applicable in larger models. We propose an approximation method that allows us to capture some of the basic insights of this literature in a standard macro-model. We are able to identify an important risk-channel that derives from the risk aversion of constrained intermediaries and that contributes significantly to the overall financial and macro volatility. With this procedure, we obtain a consistent and computationally-efficient modelling device that can be used for integrating financial stability concerns within the traditional monetary policy analysis.

Suggested Citation

Dewachter, Hans and Wouters, Rafael, Endogenous Risk in a DSGE Model with Capital-Constrained Financial Intermediaries (September 2012). National Bank of Belgium Working Paper No. 235. Available at SSRN: https://ssrn.com/abstract=2160875 or http://dx.doi.org/10.2139/ssrn.2160875

Hans Dewachter (Contact Author)

Catholic University of Leuven (KUL) - Department of Economics ( email )

Center for Economic Studies
Naamsestraat 69
Leuven, B-3000
Belgium
+0032 16 326859 (Phone)
+0032 16 326796 (Fax)

Erasmus Research Institute of Management (ERIM)

P.O. Box 1738
3000 DR Rotterdam
Netherlands

Rafael Wouters

National Bank of Belgium ( email )

Brussels, B-1000
Belgium
+32 2 221 5441 (Phone)
+32 2 221 3162 (Fax)

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