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1 results

  • THE WELFARE COST OF EXCESS VOLATILITY IN INCOMPLETE MARKETS WITH SUNSPOTS

  • Minwook Kang
  • Journal:
    Macroeconomic Dynamics / Volume 23 / Issue 3 / April 2019
    Published online by Cambridge University Press:
    27 April 2017, pp. 1062-1073

  • 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.