A continuous-time macro-finance model with Knightian uncertainty

Jie Mao, Guanxiong Shen and Jingzhou Yan

Pacific-Basin Finance Journal, 2023, vol. 77, issue C

Abstract: This study presents a continuous-time macro-finance model with Knightian uncertainty to solve the full equilibrium dynamics of the economy and examine the impacts of Knightian uncertainty on systemic risk, which we find to be asymmetric and dependent on the state of the economy. We summarize this phenomenon as the Knightian uncertainty paradox: uncertainty increases systemic risk by reducing market liquidity in the normal regime, but mitigates it by lowering leverage in the crisis regime. Thereafter, we confirm the existence of this paradox using data from China. Additionally, the impacts of macro-prudential policies are evaluated. We confirm that these policies effectively mitigate systemic risk and postpone the Minsky moment; however, they are detrimental to social welfare and retard economic recovery.

Keywords: Knightian uncertainty; Continuous-time macro-finance model; Full equilibrium dynamics; Systemic risk; Minsky moment (search for similar items in EconPapers)
JEL-codes: D81 E32 E69 G01 G12 (search for similar items in EconPapers)
Date: 2023
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:pacfin:v:77:y:2023:i:c:s0927538x22002244

DOI: 10.1016/j.pacfin.2022.101929

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