Macro-Finance Models with Nonlinear Dynamics

Winston Dou, Xiang Fang, Andrew W. Lo () and Harald Uhlig ()
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Xiang Fang: HKU Business School, The University of Hong Kong, Hong Kong SAR, China
Andrew W. Lo: Sloan School of Management, Massachusetts Institute of Technology, Cambridge, Massachusetts, USA

Annual Review of Financial Economics, 2023, vol. 15, issue 1, 407-432

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: DSGE models; dynamic stochastic general equilibrium models; systemic risk; endogenous jump risk; financial constraints; liquidity (search for similar items in EconPapers)
JEL-codes: C51 G12 G29 (search for similar items in EconPapers)
Date: 2023
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DOI: 10.1146/annurev-financial-110921-112053

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