This paper presents a macroeconomic model with a financial sector that explores 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 innovations like securitization and derivatives can lead to better risk sharing but also increase 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 ability of experts to finance their projects, leading to changes in wealth distribution and aggregate productivity. The model incorporates financial constraints, with experts facing equity issuance constraints and households providing fully elastic debt funding. The equilibrium price of capital is determined endogenously by the agents' net worth and financial constraints. The model shows that the system's reaction to shocks is highly nonlinear, with small shocks having large effects on the economy when the system is away from the steady state. The system's reaction to shocks is also asymmetric, with positive shocks leading to larger payouts and little amplification, while large negative shocks are amplified into crises episodes. The model also shows that increased volatility in the crisis regime affects the experts' precautionary motive, leading to price drops in anticipation of the crisis and higher expected returns in times of increased endogenous risk. The paper also discusses the implications of the model for financial regulation, arguing in favor of 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 supports macro-prudential regulation, emphasizing the need to restrict payouts based on the aggregate net worth of all intermediaries. 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 highlights the importance of financial innovation, showing that while it can reduce the costs of idiosyncratic shocks, it can also amplify systemic risks.This paper presents a macroeconomic model with a financial sector that explores 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 innovations like securitization and derivatives can lead to better risk sharing but also increase 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 ability of experts to finance their projects, leading to changes in wealth distribution and aggregate productivity. The model incorporates financial constraints, with experts facing equity issuance constraints and households providing fully elastic debt funding. The equilibrium price of capital is determined endogenously by the agents' net worth and financial constraints. The model shows that the system's reaction to shocks is highly nonlinear, with small shocks having large effects on the economy when the system is away from the steady state. The system's reaction to shocks is also asymmetric, with positive shocks leading to larger payouts and little amplification, while large negative shocks are amplified into crises episodes. The model also shows that increased volatility in the crisis regime affects the experts' precautionary motive, leading to price drops in anticipation of the crisis and higher expected returns in times of increased endogenous risk. The paper also discusses the implications of the model for financial regulation, arguing in favor of 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 supports macro-prudential regulation, emphasizing the need to restrict payouts based on the aggregate net worth of all intermediaries. 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 highlights the importance of financial innovation, showing that while it can reduce the costs of idiosyncratic shocks, it can also amplify systemic risks.