Financial innovation in recent decades has expanded portfolio choice. We investigate how greater choice affects investors' savings and asset returns. We establish a choice channel by which greater portfolio choice increases investors' savings—by enabling them to earn the aggregate risk premium...

We provide evidence of the stock market wealth effect on consumption by using a local labor market analysis and regional heterogeneity in stock market wealth. An increase in local stock wealth driven by aggregate stock prices increases local employment and payroll in nontradable industries and...

While the traditional view of financial innovation emphasizes the risk sharing role of new financial assets, belief disagreements about these assets naturally lead to speculation, which represents a powerful economic force in the opposite direction. This paper investigates the effect of...

During extreme financial crises, all of a sudden, the financial world that was once rife with profit opportunities for financial institutions (banks, for short) becomes exceedingly complex. Confusion and uncertainty follow, ravaging financial markets and triggering massive flight-to-quality...

Financial assets provide return and liquidity services to their holders. However, during severe financial crises many asset prices plummet, destroying their liquidity provision function at the worst possible time. In this paper we present a model of fire sales and market breakdowns, and of the...

In this paper we: (i) provide a model of the endogenous risk intolerance and severe aggregate demand contractions following a large real (non-financial) shock; and (ii) demonstrate the effectiveness of Large Scale Asset Purchases (LSAPs) in addressing these contractions. The key mechanism stems...

We provide a continuous-time “risk-centric” representation of the New Keynesian model, which we use to analyze the interactions between asset prices, financial speculation, and macro- economic outcomes when output is determined by aggregate demand. In principle, interest rate policy is...

We analyze optimal monetary policy when asset prices influence aggregate demand with a lag (as is well documented). In this context, as long as the central bank's main objective is to minimize the output gap, the central bank optimally induces asset price overshooting in response to the...

We investigate the role of macroprudential policies in mitigating liquidity traps driven by deleveraging, using a simple Keynesian model. When constrained agents engage in deleveraging, the interest rate needs to fall to induce unconstrained agents to pick up the decline in aggregate demand....

We propose a tractable model of bargaining with optimism. The distinguishing feature of our model is that the bargaining power is durable and changes only due to important events such as elections. Players know their current bargaining powers, but they can be optimistic that events will shift...