Dissecting Mechanisms of Financial Crises: Intermediation and Sentiment

Arvind Krishnamurthy and Wenhao Li

No 27088, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: 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. The model accounts for the entire crisis cycle, matching 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 slow post-crisis recovery in output. Both the intermediation and belief mechanism are essential to match the crisis cycle. However, modeling the belief variation via either a Bayesian or diagnostic model can match the broad patterns.

JEL-codes: E7 G01 (search for similar items in EconPapers)
Date: 2020-05
New Economics Papers: this item is included in nep-ban and nep-fdg
Note: AP CF EFG
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Citations: View citations in EconPapers (17)

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Working Paper: Dissecting Mechanisms of Financial Crises: Intermediation and Sentiment (2020)
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