Price-level volatility and welfare in incomplete markets with sunspots

Minwook Kang

Journal of Mathematical Economics, 2015, vol. 56, issue C, 58-66

Abstract: In an economy with incomplete financial markets as described by Cass (1989), there is typically a continuum of equilibria driven by sunspots. In some cases, there is no Pareto ranking among the different sunspot equilibria. However, this paper shows that a sunspot equilibrium with lower price-volatility is superior in economic welfare to one with higher price-volatility based on a compensation test of balanced tax-transfer plans. Specifically, I start with a non-singular benchmark equilibrium. For any nearby equilibrium prices with smaller volatility, there exists a small redistribution of first period endowments that achieves an equilibrium with the same price-volatility but is yet Pareto-superior to the benchmark equilibrium. Such a Pareto-improving redistribution does not exist for the nearby equilibrium with higher price-volatility.

Keywords: Price-level volatility; Market incompleteness; Sunspots; Pareto-improving redistribution; Excess volatility; Kaldor criterion (search for similar items in EconPapers)
Date: 2015
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:mateco:v:56:y:2015:i:c:p:58-66

DOI: 10.1016/j.jmateco.2014.12.003

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