Three Essays On Dynamic Stochastic General Equilibrium Models With Heterogeneous Agents And Financial Frictions

Other Titles


The thesis consists of three essays. The first essay develops a two-country heterogeneous-agents model with equilibrium default to explore the impact of financial integration between emerging countries and the U.S. The model shows that inefficient credit monitoring in emerging countries makes the borrowers in these countries more prone to default. The higher default risk makes financial intermediation in emerging countries less efficient (e.g. higher interest rate spread, higher default rate and lower borrowing capacity). Thus, households in emerging countries rely more on their own savings to hedge against future uncertainty. As a result, these countries have higher saving rate and lower saving return than the U.S. Given this logic, once funds are allowed to move across borders, money will move from emerging countries to the U.S seeking higher return. Thus, in the long run, the U.S gradually accumulates foreign liability along with depressed interest rate and relaxed credit limit. Meanwhile, the wealth inequality of the U.S gradually increases, whereas the consumption inequality in the U.S is mitigated due to the expanded consumer credit. The results are opposite for emerging countries. The second essay uses the modeling framework developed in the essay One to draw important policy lessons pertaining to how an emerging country should liberalize its capital account from an initial state of financial autarky. The model shows that, due to the inefficient financial intermediation, financial opening up by emerging countries may trigger a capital outflow in the short run. The sudden capital outflow raises the interest rate and crowds out domestic credit in emerging countries, and therefore a fraction of households in these countries become financially distressed, potentially leading to a liquidity crisis. The paper then shows that financial integration has different welfare impacts across households. For example, in emerging economies, rich households benefit from the financial integration but poor suffer. Gradual change in financial openness mitigates these differences leading to a higher overall welfare. Accordingly, the paper argues for a more gradual approach to capital account opening for emerging countries. The third essay explores the linkage between financial disruptions and business cycles by studying the full equilibrium dynamics of an economy with two regimes, "normal business cycles" and "financial disruptions". The system behaves differently across the two regimes. During normal cycles, the economy is fluctuating around the center of the stochastic steady state where agents are able to maintain optimal capital stock through collateral borrowing. During the episodes of financial disruptions, the productive agents are financially constrained and the economy may deviate from its efficient state, followed by a sharp decline in output and capital price as well as a joint increase in risk premium and the Sharpe ratio. The basic mechanism of the model is the following: since the return on capital is higher if it is owned by high-productivity agents, in equilibrium high-productivity agents accumulate capital stocks through leverage. Due to the debt enforcement problem, there is a maximum level of leverage determined by the financial market, which depends on the market's projection of the future value of collateral. The equilibrium leverage of high-productivity agents occasionally hits the endogenous maximum level, in which case financial disruptions occur. Because of the precautionary motive, there is only a low probability that the leverage constraint binds, while the absence of constraint characterizes the economy most of the time. Therefore, the likelihood of financial disruption depends on the history of macro shocks and individual actions that affect the equilibrium leverage. In other words, financial disruptions are endogenous rare episodes evolved over business cycles.

Journal / Series

Volume & Issue



Date Issued




international finance; Default; financial friction


Effective Date

Expiration Date




Union Local


Number of Workers

Committee Chair

Tsyrennikov, Viktor

Committee Co-Chair

Committee Member

Prasad, Eswar Shanker
Razin, Assaf

Degree Discipline


Degree Name

Ph. D., Economics

Degree Level

Doctor of Philosophy

Related Version

Related DOI

Related To

Related Part

Based on Related Item

Has Other Format(s)

Part of Related Item

Related To

Related Publication(s)

Link(s) to Related Publication(s)


Link(s) to Reference(s)

Previously Published As

Government Document




Other Identifiers


Rights URI


dissertation or thesis

Accessibility Feature

Accessibility Hazard

Accessibility Summary

Link(s) to Catalog Record