AØKK08206U Financial Frictions, Liquidity, and the Business Cycle (F)

Volume 2019/2020

MSc programme in Economics – elective course

The course is part of the Financial line at the MSc programme in Economics,   symbolized by ‘F’.


The PhD Programme in Economics at the Department of Economics - elective course with research module. PhD students must contact the study administration and the lecturer in order to register for the research module.


MSc programme in mathematics-economics


This course examines the basic channels through which financial frictions affect macroeconomic outcomes. Emphasis will be given to the transmission mechanisms that lead to amplification and persistence of shocks, including the role played by liquidity. Using several general equilibrium models we will learn more thoroughly the functioning of financial markets, why they are prone to crises, and the rationale for financial regulation.

Learning Outcome

After completing the course, the student should be able to:


  • Understand the basic imperfect information models of moral hazard and asymmetric information and their applications to the understanding of financial intermediation.
  • Use these tools to understand how frictions lead to the amplification and persistence of shocks.



  • Manage the topics, methods, tools and theories learned during the course.
  • Analyze the role of different financial frictions
  • Be proficient in the application of the concepts and methods which can be then used in other courses or in a future job after graduation.



  • Analyze a macroeconomic problem, where the above‐mentioned concepts and methods are central, that is competence in solving such models and explaining in economic terms the results and implications and how they derive from the assumptions of the model.



  • Tirole J., “The Theory of Corporate Finance”, 2006, Princeton University Press
  • Barth, J., R. Brumbaugh, and J. Wilcox, 2000, “Policy Watch: The Repeal of Glass-Steagal and the Advent of Broad Banking”, The Journal of Economic Perspectives, 14(2), 191-204.
  • Adrian, T. and H. Shin, 2010, “Liquidity and leverage”, Journal of Financial Intermediation, 19, 418-437.
  • Mian, A. and A. Sufi, 2010, “The great recession: Lessons from microeconomic data”, American Economic Review: Papers and Proceedings, 100, 1-10.
  • Stiglitz J. and A. Weiss, 1981, “Credit Rationing in Markets with Imperfect Information”, American Economic Review, 71, 393-410
  • Bernanke, B. and M. Gertler, 1989, “Agency costs, net worth, and business fluctuations”, American Economic Review, 79, p.14-31.
  • Bernanke B. and M. Gertler, 1990, “Financial Fragility and Economic Performance”, Quarterly Journal of Economics, 105, 87-114.
  • Shleifer A. and R. Vishny, 1992, “Liquidation values and debt capacity: A market equilibrium approach”, Journal of Finance, 47, 1343-1366.
  • *Kiyotaki N. and J. Moore, 1997, “Credit Cycles”, Journal of Political Economy, 76, 47-71.
  • Fanelli S., and M. Gonzalez-Eiras, 2017, “Resolution of Collateral Crises”, working paper.
  • Lorenzoni, G., 2008, “Inefficient credit booms”, Review of Economic Studies, 75, 809-833.
  • Hart O. and L. Zingales, 2014, “Liquidity and Inefficient Investment”, Journal of the European Economic Association, forthcoming.
  • Kurlat P., 2013, “Lemons Market and the Transmission of Aggregate Shocks”, American Economic Review, 103(4), 1463-89.
  • Gorton G. and G. Ordonez, 2014, “Collateral Crises”, American Economic Review, 104(2), 343-78.
  • Asriyan V., 2015, “Balance Sheet Recessions with Informational and Trading Frictions”, CREI working paper.
  • Geanakoplos J., 2009, “The leverage cycle”, in Acemmoglu D., K. Rogoff and M. Woodford, eds., NBER Macroeconomics Annual.
  • Gorton G. and A. Metrick, 2011, “Securitized banking and the run on repo”, Journal of Financial Economics, 104(3), 425-451.
  • Kashyap, Anil K and Jeremy C. Stein, 2000, “What Do a Million Observations on Banks Say About the Transmission of Monetary Policy?”, American Economic Review, Volume 90(3), 407-428.
  • Chodorow-Reich G., 2014, “The Employment Effect of Credit Market Disruptions: Firm-level Evidence from the 2008-09 Financial Crisis”, Quarterly Journal of Economics, 129(1), 1-59.
  • Diamond D. and P. Dybvig, 1983, “Bank Runs, Deposit Insurance, and Liquidity”, Journal of Political Economy, 91, 401-419.
  • Allen F. and D. Gale, 2004, “Financial Intermediaries and Markets”, Econometrica, 72, 1023-1062.
  • Farhi E., M. Golosov and A. Tsyvinski, 2009, “A theory of liquidity and regulation of financial intermediation”, Review of Economic Studies, 76(3), 973-992.
  • Ennis H. and T. Keister, 2009, “Bank Runs and Institutions: The Perils of Intervention”, American Economic Review, 99(4), 1588-1607
  • Holmstrom B., and J. Tirole, 1998, “Private and Public Supply of Liquidity”, Journal of Political Economy, 106, 1-40.
  • Sundaresan S. and Z. Wang, 2009, “Y2K Options and the Liquidity Premium in Treasury Markets”, Review of Financial Studies, 22(3), 1021-1056
  • Krishnamurthy A. and A. Vissing-Jorgensen, 2012, “The Aggregate Demand for Treasury Debt”, Journal of Political Economy, 120(2), 233-267
  • Mian A. and A. Sufi, 2011, “House Prices, Home Equity-Based Borrowing, and the US Household Leverage Crisis”, American Economic Review, Volume 101(5), 2132-56.
  • Eggertson G. and P. Krugman, 2012, “Debt, Deleveraging, and the Liquidity Trap: A Fisher-Minsky-Koo Approach”, Quarterly Journal of Economics, Volume 127, 1469-1513.
  • Justiniano A., G. Primiceri and A. Tambalotti, 2015, “Household leveraging and deleveraging, Review of Economic Dynamics, Volume 18(1), 3-20.
  • Allen F., and D. Gale, 2000, “Financial contagion, Journal of Political Economy, 108, 1-33.
  • Kiyotaki N. and J. Moore, 2002, “Balance-sheet contagion”, American Economic Review: Papers and Proceedings, 92, 46-50.
  • Caballero R. and A. Krishnamurthy, 2008, “Collective risk management in a flight to quality episode”, Journal of Finance, 63, 2195-2230.
  • Acemoglu D., A. Ozdaglar and A. Tahbaz-Salehi, 2015. “Systemic Risk and Stability in Financial Networks”, American Economic Review, 105(2), 564-608.
  • Freixas X. and J. Rochet, 2008, “Microeconomics of Banking”, MIT Press chapter 7.7
  • Gonzalez-Eiras, M., 2004, “Banks’ Liquidity Demand in the Presence of a Lender of Last Resort”, working paper.
  • Miron J., 1986, “Financial Panics, the seasonality of the nominal interest rate, and the founding of the Fed”, American Economic Review, 76, 125-40.
  • Rochet J. and X. Vives, 2004, “Coordination Failures and the Lender of Last Resort: Was Bagehot Right after all?”, Journal of the European Economic Association, 2(6), 1116-1147.
It is strongly recommended that Macroeconometrics III from the Study of Economics, Copenhagen University, or similar has been followed prior to taking the course.
Lectures and exercise classes.

At the beginning of each lecture, there will be a short, five minutes-long, open-book quiz on a starred reading from the reading list (this will be preannounced if unclear from syllabus). Quizzes will be graded 0, ½ or 1, depending on performance.

After you have finished, a random decision will be made on whether to grade or not that day’s quiz. If the outcome is YES you should hand in the quiz which will be graded by the following lecture. If the outcome is NO, the quiz will not be graded, with the following exception: Each student has a wild card to use once and only once when the outcome is NO. He or she can have their quiz graded, this grade replacing their lowest grade at the end of the course.

If at the end of the course there were N quizzes with outcome YES, a student needs at least N/2 points to be able to take the final exam.
3 hours lectures one time a week from week 6 to 20 (except holidays).
2 hours exercise classes from week X to Y (except holidays).

The overall schema can be seen at KUnet:
MSc in Economics => "courses and teaching" => "Planning and overview" => "Your timetable"
KA i Økonomi => "Kurser og undervisning" => "Planlægning og overblik" => "Dit skema"

Timetable and venue:
To see the time and location of lectures and exercise classes please press the link under "Se skema" (See schedule) at the right side of this page (E means Autumn, F means Spring).

You can find the similar information in English at
-Select Department: “2200-Økonomisk Institut” (and wait for respond)
-Select Module:: “2200-F20; [Name of course]”
-Select Report Type: “List – Weekdays”
-Select Period: “Forår/Spring – Week 5-30”
Press: “ View Timetable”

Please be aware regarding exercise classes:
- The schedule of the exercise classe can be changed until just before the teaching begins without the participants accept. If this happens it will be informed at the links in the right side, in the app myUCPH and at your personal schema at KUnet.
- If too many students have wished a specific class, students will be registered randomly at another class.
- It is not possible to change class after the second registration period has expired.
- The student is not allowed to participate in an exercise class not registered, because the room has only seats for the amount of registered student.
- That the study administration allocates the students to the exercise classes according to the principles stated in the KUnet.
  • Category
  • Hours
  • Exam
  • 3
  • Lectures
  • 42
  • Preparation
  • 161
  • Total
  • 206
7,5 ECTS
Type of assessment
Written assignment, 3 hours
The exam assignment is given in English and must be answered in English.

The Board of Study has decided to change the exam to an online take-home exam, due to the Corona-crisis. The exam is still individual and you may not communicate with others about the exam assignment or solutions in any circumstances.
Exam registration requirements

The student must have taken an amount of quizzes as stated in the Teaching and learning methods.   



With aids


Marking scale
7-point grading scale
Censorship form
No external censorship
for the written exam. The exam may be chosen for external censorship by random check.
Exam period

The exam takes place:

May 29, 2020


Exam information:

The exact time will be available in the Digital Exam  from the middle of the semester.


In special cases, the exam date can be changed to another day and time within the exam period.


For enrolled students more information about examination, rules etc. is available at the intranet for Master students (UK) and Master students (DK).



The written reexam takes place:

August 26, 2020

The re-sit is changed to an online take-home exam.


NOTE: If only few students register for the written re-exam, the re-exam might change to an online oral examination with aids, but without preparation time. If changed to an oral re-exam, the exam date, time and place might change as well. The Examination's Office then inform the students by KU e-mail.


Reexam info:

Info is available in Digital Exam early August.

More info at Master(UK), Master(DK) and Bachelor(DK).

Criteria for exam assesment

Students are assessed on the extent to which they master the learning outcome for the course.


To receive the top grade, the student must with no or only a few minor weaknesses be able to demonstrate an excellent performance displaying a high level of command of all aspects of the relevant material and can make use of the knowledge, skills and competencies listed in the learning outcomes.