Suleyman Basak () (London Business School and CEPR) David Cass () (Department of Economics, University of Pennsylvania) Juan Manuel Licari () (Department of Economics, University of Pennsylvania) Anna Pavlova () (London Business School and CEPR)
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This paper explores the role of portfolio constraints in generating multiplicity of equilibrium. We present a simple asset market economy with two goods and two households, households who face constraints on their ability to take unbounded positions in risky stocks. Absent such constraints, equilibrium allocation is unique and is Pareto efficient. With a single portfolio constraint in place, the efficient equilibrium is still possible; however, additional inefficient equilibria in which the constraint is binding may emerge. We show further that with sunspots, there may be a continuum of equilibria; sunspots may lead to real indeterminacy. Extending our analysis of sunspot phenomena to three periods, we show that our model is also capable of generating moves in stock prices unrelated to so-called fundamentals; such movements are triggered purely by sunspots which only affect investors'(rational) expectations about future market behavior. This provides a simple, coherent explanation for the apparent inability of empirical studies to link many sharp price movements in stock markets to news about economic fundamentals.
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Paper provided by Penn Institute for Economic Research, Department of Economics, University of Pennsylvania in its series PIER Working Paper Archive with number
06-012.
References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
Cass, David & Pavlova, Anna, 2003.
"On Trees And Logs,"
Working papers
4233-02, Massachusetts Institute of Technology (MIT), Sloan School of Management.
[Downloadable!]
Pavlova, Anna & Cass, David, 2002.
"On Trees and Logs,"
Working papers
4233-02, Massachusetts Institute of Technology (MIT), Sloan School of Management.
[Downloadable!]
David Cass & Anna Pavlova, .
"On Trees and Logs,"
CARESS Working Papres
00-01, University of Pennsylvania Center for Analytic Research and Economics in the Social Sciences.
[Downloadable!]
David M. Cutler & James M. Poterba & Lawrence H. Summers, 1989.
"What Moves Stock Prices?,"
NBER Working Papers
2538, National Bureau of Economic Research, Inc.
[Downloadable!] (restricted)
Other versions:
David H. Cutler & James M. Poterba & Lawrence H. Summers, 1988.
"What Moves Stock Prices?,"
Working papers
487, Massachusetts Institute of Technology (MIT), Department of Economics.
Cited by: (explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)