Options, Sunspots, and the Creation of Uncertainty

Abstract

We present two examples in which the addition of an option market leads to sunspot equilibria despite the fact that no sunspot equilibria exist without the market. These examples highlight limitations in two prevalent views of option markets. It is often assumed that option markets help complete otherwise incomplete markets. We demonstrate that they can instead increase the number of events agents wish to insure against. As in Black and Scholes, it is often assumed that option markets are redundant. We demonstrate that an option market may not be redundant even when markets were complete before its introduction.