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Trading on Sunspots

Author

Listed:
  • Boyan Jovanovic
  • Viktor Tsyrennikov

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.

Suggested Citation

  • Boyan Jovanovic & Viktor Tsyrennikov, 2022. "Trading on Sunspots," American Economic Review, American Economic Association, vol. 112(12), pages 3970-3994, December.
    • Handle: RePEc:aea:aecrev:v:112:y:2022:i:12:p:3970-94
    DOI: 10.1257/aer.20210972
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    JEL classification:

    • D51 - Microeconomics - - General Equilibrium and Disequilibrium - - - Exchange and Production Economies
    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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