The Financial Instability Hypothesis: A Stochastic Microfoundation Framework

Carl Chiarella and Corrado Di Guilmi

No 273, Research Paper Series from Quantitative Finance Research Centre, University of Technology, Sydney

Abstract: This paper examines the dynamics of financial distress and in particular the mechanism of transmission of shocks from the financial sector to the real economy. The analysis is performed by representing the linkages between microeconomic financial variables and the aggregate performance of the economy by means of a microfounded model with firms that have heterogeneous capital structures. The model is solved both numerically and analytically, by means of a stochastic approximation that is able to replicate quite well the numerical solution. These methodologies, by overcoming the restrictions imposed by the traditional microfounded approach, enable us to provide some insights into the stabilization policies which may be effective in a financially fragile system.

Keywords: financial fragility; complex dynamics; stochastic aggregation (search for similar items in EconPapers)
JEL-codes: E12 E22 E44 (search for similar items in EconPapers)
Pages: 29 pages
Date: 2010-03-01
New Economics Papers: this item is included in nep-bec, nep-mac, nep-ore and nep-pke
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Citations: View citations in EconPapers (3)

Published as: Chiarella, C. and Di Guilmi, C., 2011, "The Financial Instability Hypothesis:a Stochastic Microfoundation Framework", Journal of Economic Dynamics and Control, 35(8), 1151-1171.

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Related works:
Journal Article: The financial instability hypothesis: A stochastic microfoundation framework (2011)
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