Building on previous works on business fluctuations, we model the propagation of financial distress in a network of regions, each populated by heterogeneous interacting firms and banks. In order to diversify risk, firm sell goods outside their own region and borrow from banks located there. However, this results in ties across regions which propagate financial distress across regional borders. We investigate how the average level of economic integration affects the probability of both individual and systemic failures. We find that the benefit of greater diversification is eventually offset by the effect of financial acceleration and contagion. In particular, beyond a certain level of integration the economy suffers more frequently from events with larger numbers of simultaneous failures.
This chapter starts by reflecting on the notion of "value" in economics. It then describes how economic decision-making models are framed and examines their moral dimension. The foundations of traditional economic decision-making models contrast with the emphasis of psychological research on the role of deontological considerations in decision-making. The focus is on a specific deontological value, so called "protected values". The chapter describes the main characteristics of individuals endowed with protected values in particular when these values focus on honesty, and reviews experimental evidence on the role of protected values for honesty in economic decision-making. Finally, some speculative thoughts are offered on the relevance of research on moral values for business policies, incentive design, and regulation. Also discussed are some open research questions regarding the role of moral values in economic decision-making.
Prior to the crisis the dominant paradigm in macroeconomic modeling was the micro-founded "New-Keynesian" DSGE model (described in many textbooks including the influential exposition of Woodford (2003)). In its most basic form this combines price-stickiness with forward looking decision making by both households and firms. This provides a tractable framework for capturing the response of output and inflation to both demand and supply shocks and explaining intuitively the transmission of monetary policy (with monetary policy characterized as a choice over rules for current and future interest rates).
The creation and protection of financial wealth is one of the most important roles of modern societies. People will commit to working hard and saving for future generations only if they can be sure that the efforts they exert every day will be rewarded by a better standard of living. This, however, can only be achieved with a well-functioning financial market. Unfortunately, a breakdown of the financial system as in the great financial crisis of 2007 and 2008 destroys the trust in this important social arrangement. To avoid such crises we need to improve our understanding of financial markets that, so far, has been built on totally unrealistic assumptions about the behavior of people acting in them. The most fundamental and at the same time the most questionable in modern economic theory is the hypothesis of full rationality of economic agents who are assumed to maximize their utility functions subject to their individual constraints, or in mathematical language, solve well-defined and precisely stated constrained optimization problems.
Central bank collateral frameworks are an often overlooked feature of monetary policy that play a key role in the monetary and financial system. Readers will discover how central banks conduct and implement monetary policy beyond merely setting interest rates, and develop their understanding as to how collateral policies may affect financial markets, financial stability, and the real economy. This book studies the collateral framework in the euro area in detail, and levers this analysis to provide an account of the euro crisis from the perspective of collateral policy. Readers gain access to a wealth of institutional and economic data and information with a level of density and accessibility unavailable elsewhere. This book, the first of its kind, is a valuable read for academic monetary and financial economists, those working in banking and policy-making financial institutions, and anyone who wishes to learn more about the role of central banks in society.
Classical option pricing theories are usually built on the law of one price, neglecting the impact of market liquidity that may contribute to significant bid-ask spreads. Within the framework of conic finance, we develop a stochastic liquidity model, extending the discrete-time constant liquidity model of Madan (2010). With this extension, we can replicate the term and skew structures of bid-ask spreads typically observed in option markets. We show how to implement such a stochastic liquidity model within our framework using multidimensional binomial trees and we calibrate it to call and put options on the S&P 500.
