452 Uris Hall
Ithaca, NY 14853
Institutional Affiliation: New York University
Information about this author at RePEc
NBER Working Papers and Publications
|December 2014||Trading on Sunspots|
with Boyan Jovanovic: w20813
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.