American Economic Review
ISSN 0002-8282 (Print) | ISSN 1944-7981 (Online)
Trading on Sunspots
American Economic Review
(pp. 3970–94)
Abstract
In a model with multiple Pareto-ranked equilibria, we show that the set of equilibria shrinks if we allow trade in assets that pay based on the realization of a sunspot acting as an equilibrium-selection device. When the probability of a low-output outcome is high, the desire to insure against it leads the poor to promise large transfers to the rich in the high-output state. The rich then lose the incentive to exert the effort needed to sustain the high output. Thus the opening of financial markets may destroy the high equilibrium.Citation
Jovanovic, Boyan, and Viktor Tsyrennikov. 2022. "Trading on Sunspots." American Economic Review 112 (12): 3970–94. DOI: 10.1257/aer.20210972Additional Materials
JEL Classification
- D51 Exchange and Production Economies
- D53 General Equilibrium and Disequilibrium: Financial Markets
- D82 Asymmetric and Private Information; Mechanism Design
- E44 Financial Markets and the Macroeconomy
- G12 Asset Pricing; Trading Volume; Bond Interest Rates
- G14 Information and Market Efficiency; Event Studies; Insider Trading
- G21 Banks; Depository Institutions; Micro Finance Institutions; Mortgages