On the Uniqueness of the Bubble-Free Solution in Linear Rational Expectations Models
Bubble solutions of rational expectations models are identified by extra components that arise in addition to market fundamentals. In general there still exist many equilibrium paths relying on a minimal set of state variables, i.e., along which the number of lags that influence the current equilibrium state is equal to the number of initial conditions. Although traders beliefs do not a priori play any role in these paths, the conventional wisdom is that there should be a unique bubble-free (fundamentals) solution. The purpose of this paper is to consider this view by examining existence of endogenous stochastic sunspot fluctuations in an arbitrary small neighbourhood of the minimal-state variables paths, thereby providing a method for identifying bubble and bubble-free minimal-state variables paths.
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