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John Cochrane on Macro-Finance

Pub: 03.08.16

| By Anonymous

In Finance.

Tags: finance academics .

Financial modelling in a nutshell, from the summary at the end of the paper:

"Given the fact that the state variables are so correlated, and that the models are all quantitative parables not detailed models-of-everything meant to be literally true, that effort [to distinguish between modelling approaches] may not be worth the bother. They differ, as I have pointed out, somewhat in the ratio of assumptions to predictions, and the amount of “dark matter” invoked to explain various phenomena, and more deeply they differ in the analytical convenience they each have in capturing the common ideas."

Macro-finance addresses the link between asset prices and economic fluctuations. Many models reflect the same rough idea: the market's ability to bear risk varies over time, larger in good times, and less in bad times. Models achieve this similar result by quite different mechanisms, and I contrast their strengths and weaknesses. I outline how macro-finance models may illuminate macroeconomics, by putting time-varying risk aversion, risk-bearing capacity, and precautionary savings at the center of recessions rather than variation in "the" interest rate and intertemporal substitution. I emphasize unsolved questions and profitable avenues for research.

Link to the paper: John Cochrane on Macro-Finance.