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Price-level volatility and welfare in incomplete markets with sunspots

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  • Kang, Minwook

Abstract

In an economy with incomplete financial markets as described by Cass (1989), there is typically a continuum of equilibria driven by sunspots. In some cases, there is no Pareto ranking among the different sunspot equilibria. However, this paper shows that a sunspot equilibrium with lower price-volatility is superior in economic welfare to one with higher price-volatility based on a compensation test of balanced tax-transfer plans. Specifically, I start with a non-singular benchmark equilibrium. For any nearby equilibrium prices with smaller volatility, there exists a small redistribution of first period endowments that achieves an equilibrium with the same price-volatility but is yet Pareto-superior to the benchmark equilibrium. Such a Pareto-improving redistribution does not exist for the nearby equilibrium with higher price-volatility.

Suggested Citation

  • Kang, Minwook, 2015. "Price-level volatility and welfare in incomplete markets with sunspots," Journal of Mathematical Economics, Elsevier, vol. 56(C), pages 58-66.
    • Handle: RePEc:eee:mateco:v:56:y:2015:i:c:p:58-66
    DOI: 10.1016/j.jmateco.2014.12.003
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    References listed on IDEAS

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    Cited by:

    1. Wang, Hanjie & Feil, Jan-Henning & Yu, Xiaohua, 2021. "Disagreement on sunspots and soybeans futures price," Economic Modelling, Elsevier, vol. 95(C), pages 385-393.

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