Trading on Sunspots

Boyan Jovanovic () and Viktor Tsyrennikov

No 20813, NBER Working Papers from National Bureau of Economic Research, Inc

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.

JEL-codes: E32 G1 (search for similar items in EconPapers)
Date: 2014-12
New Economics Papers: this item is included in nep-mac
Note: AP EFG
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Published as Boyan Jovanovic & Viktor Tsyrennikov, 2022. "Trading on Sunspots," American Economic Review, vol 112(12), pages 3970-3994.

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Journal Article: Trading on Sunspots (2022)
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