Taking financial frictions to the data

Hyunduk Suh and Todd Walker

Journal of Economic Dynamics and Control, 2016, vol. 64, issue C, 39-65

Abstract: We estimate a Dynamic Stochastic General Equilibrium (DSGE) model with various financial frictions and analyze how well the model explains the Great Recession. Predictive analysis shows that the model can only slightly better explain the large deviation from trend during the crisis relative to a model without financial frictions. Specifically, the risk premium shock, which is a shock to the external finance premium of the entrepreneurs׳ leverage, explains the largest part of the investment downfall during the crisis. However, the ‘balance sheet’ channel of financial frictions in the model, which structurally links balance sheet conditions of financial intermediaries and nonfinancial borrowers to their borrowing rates, is estimated to be weak. We examine alternative prior specifications for how the financial frictions enter the model and continue to find a limited role for these frictions. Rolling-window estimation provides evidence for substantial time variation in parameters governing financial frictions. We conclude that the well-known financial frictions studied in this paper are not able to explain the financial crisis in a linearized and estimated model.

Keywords: Bayesian estimation; DSGE model; Financial friction (search for similar items in EconPapers)
JEL-codes: E44 E52 E59 (search for similar items in EconPapers)
Date: 2016
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (18)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:64:y:2016:i:c:p:39-65

DOI: 10.1016/j.jedc.2015.12.001

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