Working Paper: CEPR ID: DP10402
Authors: Roger E. A. Farmer
Abstract: This paper constructs a simple model in which asset price fluctuations are caused by sunspots. Most existing sunspot models use local linear approximations: instead, I construct global sunspot equilibria. My agents are expected utility maximizers with logarithmic utility functions, there are no fundamental shocks and markets are sequentially complete. Despite the simplicity of these assumptions, I am able to go a considerable way towards explaining features of asset pricing data that have presented an obstacle to previous models that adopted similar assumptions. My model generates volatile persistent swings in asset prices, a substantial term premium for long bonds and bursts of conditional volatility in rates of return.
Keywords: Asset Prices; Sunspots
JEL Codes: E44; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Sunspot shocks (E32) | Asset price fluctuations (G19) |
| Sunspot shocks (E32) | Expectations about future price levels (D84) |
| Expectations about future price levels (D84) | Asset price fluctuations (G19) |
| Asset price fluctuations (G19) | Intergenerational wealth effects (D15) |
| Sunspot shocks (E32) | Market behavior (D40) |
| Government debt (H63) | Dynamics of asset pricing (G19) |
| Sunspot shocks (E32) | Redistribution of tax burdens (H23) |
| Redistribution of tax burdens (H23) | Asset prices (G19) |