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
There are 2 versions of this paper
Macro-Finance Models with Nonlinear Dynamics
Macro-Finance Models with Nonlinear Dynamics
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: Suggested Citation