The welfare cost of excess volatility in incomplete markets with sunspots

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3 Citations (Scopus)

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.

Original languageEnglish
Pages (from-to)1062-1073
Number of pages12
JournalMacroeconomic Dynamics
Volume23
Issue number3
DOIs
Publication statusPublished - 2017 Apr 27
Externally publishedYes

Bibliographical note

Publisher Copyright:
© 2017 Cambridge University Press.

Keywords

  • Excess Volatility
  • Market Incompleteness
  • Price-Level Volatility
  • Sunspots
  • Welfare Cost

ASJC Scopus subject areas

  • Economics and Econometrics

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