Hostname: page-component-586b7cd67f-tf8b9 Total loading time: 0 Render date: 2024-11-20T17:31:42.521Z Has data issue: false hasContentIssue false
  • English
  • Français

THE WELFARE COST OF EXCESS VOLATILITY IN INCOMPLETE MARKETS WITH SUNSPOTS

Published online by Cambridge University Press:  27 April 2017

Minwook Kang
Minwook Kang*
Affiliation:
Nanyang Technological University
*
Address correspondence to: Minwook Kang, Nanyang Technological University, 14 Nanyang Drive, HSS 04-58, Singapore 637332, Singapore; e-mail: [email protected]
Get access Rights & Permissions [Opens in a new window]

Abstract

In an incomplete markets economy with sunspots, the Pareto-criterion cannot rank sunspot equilibria of different levels of excess price-level volatility. Therefore, I propose a measure of excess volatility cost in terms of a period-0 endowment good. Ex-ante endowment subsidies are provided, in theory, to each consumer, so that the resulting equilibrium allocation of the higher volatility is Pareto-equivalent to the original benchmark equilibrium with a lower volatility level. The aggregate volatility cost is computed as the sum of all consumers' subsidies. Focusing on local analysis that considers small variations around a given volatility level, I show that the aggregate cost strictly increases in volatility even though each individual cost does not necessarily have this property.

Keywords

Excess VolatilityMarket IncompletenessPrice-Level VolatilitySunspotsWelfare Cost
Type
Articles
Information
Macroeconomic Dynamics , Volume 23 , Issue 3 , April 2019 , pp. 1062 - 1073
Copyright
Copyright © Cambridge University Press 2017 

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Footnotes

I appreciate helpful comments from Karl Shell, Larry Selden, Lei Sandy Ye, and two anonymous referees. I thank Peng Yudan and Ton My Linh for research assistance. I gratefully acknowledges research support from Nanyang Technological University (NTU) Start-up Grant and AcRF Tier-1 Grant (RG171/14).

References

REFERENCES

Antinolfi, G. and Keister, T. (1998) Options and sunspots in a simple monetary economy. Economic Theory 11 (2), 295–315.Google Scholar
Balasko, Y. (1983) Extrinsic uncertainty revisited. Journal of Economic Theory 31 (2), 203–210.Google Scholar
Bhattacharya, J., Guzman, M. G., and Shell, K. (1998) Price level volatility: A simple model of money taxes and sunspots. Journal of Economic Theory 81 (2), 401–430.Google Scholar
Calvet, L. E. (2001) Incomplete markets and volatility. Journal of Economic Theory 98 (2), 295–338.Google Scholar
Cass, D. (1989) Sunspots and incomplete fiancial markets: The leading example. In Feiwel, G. (ed.), The Economics of Imperfect Competition and Employment: Joan Robinson and Beyond. London: Macmillan.Google Scholar
Cass, D. (1991) Incomplete fiancial market and indeterminancy of competitive equilibrium. In Laffont, J. J. (ed.), Advanced in Economic Theory, 6th World Congress. London: Macmillan.Google Scholar
Cass, D. (1992) Sunspots and incomplete fiancial markets: The general case. Economic Theory 2 (3), 341–358.Google Scholar
Cass, D. and Shell, K. (1983) Do sunspots matter? Journal of Political Economy 91 (2), 193–227.Google Scholar
Citanna, A. and Schmedders, K. (2005) Excess price volatility and fiancial innovation. Economic Theory 26 (3), 559–587.Google Scholar
Constantinides, G. M. and Duffie, D. (1996) Asset pricing with heterogeneous consumers. Journal of Political Economy 104 (2), 219–240.Google Scholar
Cozzi, G., Goenka, A., Kang, M., and Shell, K. (2016) Winners and losers from price-level volatility: Money taxation and information frictions. In Nishimura, K., Venditti, A., and Yannelis, N. C. (eds.), Sunspots and Non-Linear Dynamics: Essays in Honor of Jean-Michel Grandmont, Volume 31 of Studies in Economic Theory, pp. 387–402. Switzerland: Springer International Publishing.Google Scholar
Farmer, R. E. and Guo, J.-T. (1994) Real business cycles and the animal spirits hypothesis. Journal of Economic Theory 63 (1), 42–72.Google Scholar
Farmer, R. E. and Woodford, M. (1997) Self-fulfilling prophecies and the business cycle. Macroeconomic Dynamics 1 (04), 740–769.Google Scholar
Goenka, A. and Préchac, C. (2006) Stabilizing sunspots. Journal of Mathematical Economics 42 (4–5), 544–555.Google Scholar
Kajii, A. (1997) On the role of options in sunspot equilibria. Econometrica 65 (4), 977–986.Google Scholar
Kajii, A. (2007) Welfare gains and losses in sunspot equilibria. Japanese Economic Review 58 (3), 329–344.Google Scholar
Kang, M. (2015) Price-level volatility and welfare in incomplete markets with sunspots. Journal of Mathematical Economics 56, 58–66.Google Scholar
Lucas, R. E. Jr (1987) Models of Business Cycles, vol. 26. Oxford: Basil Blackwell.Google Scholar
Lucas, R. E. Jr. (2003) Macroeconomic priorities. American Economic Review 93 (1), 1–14.Google Scholar
Mas-Colell, A. (1992) Three observations on sunspots and asset redundancy. In Dasgupta, P., Gale, D., Hart, O., and Maskin, E. (eds.), Economic Analysis of Markets and Games: Essays in Honor of Frank Hahn, pp. 465–474. Cambridge, MA: MIT Press.Google Scholar
Peck, J. and Shell, K. (2003) Equilibrium bank runs. Journal of Political Economy 111 (1), 103–123.Google Scholar
Shiller, R. J. (1992) Market Volatility. Cambridge, UK: MIT Press.Google Scholar
Siconolfi, P. (1991) Sunspot equilibria and incomplete fiancial markets. Journal of Mathematical Economics 20 (3), 327–339.Google Scholar