Trading on Sunspots
Boyan Jovanovic, Viktor Tsyrennikov
American Economic Review · 2022 · Volume 112 · Issue 12
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.
Keywords
Exchange and Production Economies, General Equilibrium and Disequilibrium: Financial Markets, Asymmetric and Private Information, Mechanism Design, Financial Markets and the Macroeconomy, Asset Pricing, Trading Volume, Bond Interest Rates, Information and Market Efficiency, Event Studies, Insider Trading, Banks, Depository Institutions, Micro Finance Institutions, Mortgages
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