This paper presents a macroeconomic model with a financial sector, analyzing the dynamics of an economy with financial frictions. The model shows that financial frictions can lead to instability and volatile episodes, with risk being endogenous and asset price correlations high during downturns. The paper highlights the volatility paradox, where lower exogenous risk can lead to more extreme volatility spikes due to higher equilibrium leverage. Financial innovation, such as securitization and derivatives, can lead to better sharing of exogenous risk but increase endogenous systemic risk. The model also shows that financial experts may impose a negative externality on each other and the economy by not maintaining adequate capital cushions. The model considers two types of agents: productive experts and less productive households. Financial frictions affect the wealth of experts, influencing their ability to invest in physical capital. The model uses continuous-time methodology to solve for the full dynamics of the system, capturing both near and away from the steady state. The steady state is endogenously determined through risk-taking and payout decisions, leading to an important relationship between the risk environment and equilibrium leverage. The model shows that the system's reaction to shocks is highly nonlinear, with small shocks having large effects on the economy. The system is resilient to most shocks near the steady state, but unusually large shocks get amplified, leading to significant endogenous risk. The model also shows that the system's reaction to shocks is asymmetric, with positive shocks leading to larger payouts and little amplification, while large negative shocks are amplified into crises episodes. The model has important asset pricing implications, showing that credit spreads and risk premia increase in crisis regimes, and asset prices become more correlated due to endogenous risk. The model also shows that financial innovation can be self-defeating, as it leads to higher systemic risk. The model also highlights the importance of macro-prudential regulation, arguing for countercyclical regulation that encourages financial institutions to retain earnings and build up capital buffers in good times and relaxes constraints in downturns. The model also shows that financial crises can lead to spillovers into the real economy, and that regulation is subject to time inconsistency.This paper presents a macroeconomic model with a financial sector, analyzing the dynamics of an economy with financial frictions. The model shows that financial frictions can lead to instability and volatile episodes, with risk being endogenous and asset price correlations high during downturns. The paper highlights the volatility paradox, where lower exogenous risk can lead to more extreme volatility spikes due to higher equilibrium leverage. Financial innovation, such as securitization and derivatives, can lead to better sharing of exogenous risk but increase endogenous systemic risk. The model also shows that financial experts may impose a negative externality on each other and the economy by not maintaining adequate capital cushions. The model considers two types of agents: productive experts and less productive households. Financial frictions affect the wealth of experts, influencing their ability to invest in physical capital. The model uses continuous-time methodology to solve for the full dynamics of the system, capturing both near and away from the steady state. The steady state is endogenously determined through risk-taking and payout decisions, leading to an important relationship between the risk environment and equilibrium leverage. The model shows that the system's reaction to shocks is highly nonlinear, with small shocks having large effects on the economy. The system is resilient to most shocks near the steady state, but unusually large shocks get amplified, leading to significant endogenous risk. The model also shows that the system's reaction to shocks is asymmetric, with positive shocks leading to larger payouts and little amplification, while large negative shocks are amplified into crises episodes. The model has important asset pricing implications, showing that credit spreads and risk premia increase in crisis regimes, and asset prices become more correlated due to endogenous risk. The model also shows that financial innovation can be self-defeating, as it leads to higher systemic risk. The model also highlights the importance of macro-prudential regulation, arguing for countercyclical regulation that encourages financial institutions to retain earnings and build up capital buffers in good times and relaxes constraints in downturns. The model also shows that financial crises can lead to spillovers into the real economy, and that regulation is subject to time inconsistency.