Working Paper: NBER ID: w20044
Authors: Jess Benhabib; Pengfei Wang
Abstract: We study a model where some agents have private information about risky asset returns and trade to obtain capital gains, while others acquire the risky asset and hold it to maturity, forming expectations of returns based on market prices. We show that under such a structure, in addition to fully revealing rational expectations equilibria, there exists a continuum of equilibrium prices consistent with rational expectations, where the the asset prices are subject to sunspot shocks. Such sunspot shocks can generate persistent fluctuations in asset prices that look like a random walk in an efficient market.
Keywords: The Grossman-Stiglitz Paradox; Sunspots
JEL Codes: D82; D83; G12; G14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| private information (D82) | market prices (P22) |
| sunspot shocks (E32) | market prices (P22) |
| private information (D82) | divergence from fundamental values (D46) |
| sunspot shocks (E32) | persistent fluctuations in asset prices (E32) |
| market expectations (D84) | asset prices (G19) |
| sunspot shocks (E32) | increased volatility in asset prices (G19) |