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Macro-Finance Models with Nonlinear Dynamics

Author

Listed:
  • Winston Wei Dou

    (Finance Department, The Wharton School, University of Pennsylvania, Philadelphia, Pennsylvania, USA)

  • 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)

  • Harald Uhlig

    (National Bureau of Economic Research, Cambridge, Massachusetts, USA)

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.

Suggested Citation

  • Winston Wei Dou & Xiang Fang & Andrew W. Lo & Harald Uhlig, 2023. "Macro-Finance Models with Nonlinear Dynamics," Annual Review of Financial Economics, Annual Reviews, vol. 15(1), pages 407-432, November.
    • Handle: RePEc:anr:refeco:v:15:y:2023:p:407-432
    DOI: 10.1146/annurev-financial-110921-112053
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    More about this item

    Keywords

    DSGE models; dynamic stochastic general equilibrium models; systemic risk; endogenous jump risk; financial constraints; liquidity;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G29 - Financial Economics - - Financial Institutions and Services - - - Other
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation

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