Brunnermeier's research lies at the intersection of international macro, monetary and financial economics. He primarily studies distortions caused by financial frictions. These frictions invalidate the
Efficient market hypothesis (EMH), a proposition that markets incorporate all information relevant to prices immediately and consequently the price of a given asset accurately represents the likely value of that asset.
Price efficiency, bubbles, liquidity, and systemic risk Faced with the empirical evidence that asset prices diverged from their
fundamentals during the
dot-com bubble, Brunnermeier crafted a model of trading where participants in the market would recognize
bubbles in asset prices but continue to trade "into the wind". Brunnermeier's empirical paper, coauthored with Stefan Nagel, documents that
hedge funds were riding the dot-com bubble. The paper won the
Smith Breeden Prize in 2004. Brunnermeier and
Lasse Pedersen introduced different liquidity concepts and studied
liquidity spirals, which are vicious cycles that amplify initial shocks and provide an explanation for the
2008 financial crisis. Brunnermeier with
Tobias Adrian from the
Federal Reserve Bank of New York created one of the first
systemic risk measures, the CoVaR, an alternative to value at risk which takes spillover and contagion effects between assets and industries into account.
Macroeconomy and finance Brunnermeier and
Yuliy Sannikov integrated financial frictions into macro and international economic models. Their macro models capture non-linearities that occur during crises episodes. They also introduced the concept of volatility paradox, which refers to the phenomenon that risk builds up primarily during tranquil times in background in the form of imbalances and only materializes when crises erupt.
Monetary theory and financial regulation Brunnermeier and
Sannikov's monetary paper, The I Theory of Money, studies
debt deflation à la Fisher and the interaction between (redistributive)
monetary policy and
macroprudential policy. The "Paradox of Prudence" emerges: micro-prudent behavior of individual financial institutions is not necessarily macro-prudent. His approach provides an alternative to the predominant
New-Keynesian view, in which price and wage rigidities are the primary frictions.
International financial markets Brunnermeier's work on international finance documents the link between
carry trades and currency crashes. He also analyzes sudden stops in international credit flows and other inefficiencies due to
pecuniary externalities.
Economic philosophies and Euro Further work of Brunnermeier focuses on the architecture of the
euro and the
Eurozone. His book,
The Euro and the Battle of Ideas, (together with
Harold James, from Princeton's
Department of History, and
Jean-Pierre Landau, from the
Banque de France) shows how core problems of the
euro are also linked to conflicting political and economic philosophies of the
Eurozone's founding countries, especially those of Germany and France, and discusses ways to reconcile the competing views. Brunnermeier also proposes European Safe Bonds (ESBies) in form of Sovereign Bond Backed Securities (SBBS) as a means to break the vicious circle between sovereign risk and bank risk in the
Eurozone and to rechannel flight-to-safety capital flows from cross-border flows to flows across tranches of the ESBies.
Resilience In his book,
The Resilient Society, Brunnermeier conceptualizes the notion of 'Resilience'. He argues that rather than simply avoiding risks (and therefore opportunities), the key is to distinguish between risk from which one can bounce back and risk that can trigger an adverse feedback loop. Across various policy areas, he describes how societies should be set up to increase societal resilience, which differs from individual resilience and resilience of a system.
The Resilient Society was named 'One of the Best Business Books of 2021' by the
Financial Times and won the 'Best German Business Book Prize' in 2021. ==Notes==