Macro-Finance Models with Nonlinear Dynamics

Annual Review of Financial Economics, Forthcoming

The Rodney L. White Center Working Papers Series at the Wharton School

University of Chicago, Becker Friedman Institute for Economics Working Paper

43 Pages Posted: 23 Sep 2019 Last revised: 21 Feb 2023

See all articles by Winston Wei Dou

Winston Wei Dou

University of Pennsylvania - The Wharton School; National Bureau of Economic Research (NBER)

Xiang Fang

The University of Hong Kong

Andrew W. Lo

Massachusetts Institute of Technology (MIT) - Laboratory for Financial Engineering

Harald Uhlig

University of Chicago - Department of Economics; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: October 13, 2022

Abstract

We review macro-finance models featuring nonlinear dynamics that have recently been
developed in the literature, including models with funding liquidity constraints, market
liquidity frictions, and bank run frictions, and discuss the empirical evidence and challenges of
this class of models. We also construct an illustrative model featuring financial frictions and
nonlinear dynamics for readers who are unfamiliar with the literature. We solve the model
using different solution techniques, including both global and perturbation solution methods,
and comprehensively compare the accuracy of these solutions. Within this framework, we
highlight that local linearization approximations omit important nonlinear dynamics and
yield biased impulse responses.

Keywords: Dynamic Stochastic General Equilibrium (DSGE) Models; Systemic Risk; Endogenous Jump Risk; Financial Constraints; Liquidity

JEL Classification: G12, G29, C51

Suggested Citation

Dou, Winston Wei and Fang, Xiang and Lo, Andrew W. and Uhlig, Harald, Macro-Finance Models with Nonlinear Dynamics (October 13, 2022). Annual Review of Financial Economics, Forthcoming, The Rodney L. White Center Working Papers Series at the Wharton School, University of Chicago, Becker Friedman Institute for Economics Working Paper, Available at SSRN: https://ssrn.com/abstract=3457590

Winston Wei Dou (Contact Author)

University of Pennsylvania - The Wharton School ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

HOME PAGE: http://www.nber.org/people/winston_wei_dou?page=1&perPage=50

Xiang Fang

The University of Hong Kong ( email )

Pokfulam Road
Hong Kong, Pokfulam HK
China

Andrew W. Lo

Massachusetts Institute of Technology (MIT) - Laboratory for Financial Engineering ( email )

100 Main Street
E62-618
Cambridge, MA 02142
United States
617-253-0920 (Phone)
781 891-9783 (Fax)

HOME PAGE: http://web.mit.edu/alo/www

Harald Uhlig

University of Chicago - Department of Economics ( email )

1101 East 58th Street
Chicago, IL 60637
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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