Working Paper: NBER ID: w20813
Authors: Boyan Jovanovic; Viktor Tsyrennikov
Abstract: In a model with multiple Pareto-ranked equilibria we add trade in assets that pay based on the realization of a sunspot. Asset trading restricts the equilibrium set in a way that raises welfare by eliminating equilibria with a high likelihood of disasters. When the probability of a disaster is high enough, the coordination game becomes like a prisoner’s dilemma situation in which the high-output equilibrium disappears because the portfolios that agents choose induce them to produce less. We derive an upper bound on the disaster probability, we derive asset pricing implications including the disaster premium, and we study the effect on stock prices of news shocks to beliefs.
Keywords: sunspots; asset trading; welfare; equilibria; disaster premium
JEL Codes: E32; G1
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Trade in sunspot-contingent assets (G13) | Welfare (I38) |
| High disaster probability (H84) | Disappearance of high-output equilibria (D59) |
| Probability of disasters (H84) | Disaster premium (H84) |
| News shocks to beliefs (D83) | Stock prices (G19) |
| Increased inequality (F61) | Welfare outcomes (I38) |