Survey_CT_2009

Abstract

Our model’s tractability springs from our distillation of all nonreturn risk into a stark and simple possibility: The decisionmaker might experience an uninsurable one-time permanent reduction in the flow of nonfinancial income. When that decisionmaker is an employed household, this can be interpreted as an exogenous and permanent transition into unemployment (or disability, or retirement). A similar risk is faced by a country whose exports are dominated by a commodity whose price might collapse (e.g., oil exporters, if cold fusion had worked). The model could even be interpreted as applying to the behavior of a firm controlled by a risk-neutral manager, so long as the collapse of a line of business could have the effect of reducing the firm’s collateral value and therefore increasing its cost of external finance a la Bernanke, Gertler, and Gilchrist (1996).