Trading on Sunspots

Boyan Jovanovic () and Viktor Tsyrennikov

American Economic Review, 2022, vol. 112, issue 12, 3970-94

Abstract: In a model with multiple Pareto-ranked equilibria, we show that the set of equilibria shrinks if we allow trade in assets that pay based on the realization of a sunspot acting as an equilibrium-selection device. When the probability of a low-output outcome is high, the desire to insure against it leads the poor to promise large transfers to the rich in the high-output state. The rich then lose the incentive to exert the effort needed to sustain the high output. Thus the opening of financial markets may destroy the high equilibrium.

JEL-codes: D51 D53 D82 E44 G12 G14 G21 (search for similar items in EconPapers)
Date: 2022
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Working Paper: Trading on Sunspots (2014)
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DOI: 10.1257/aer.20210972

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