In sunspot equilibrium, the allocation of resources depends on some purely extrinsic random variable – a random variable that has no effect on the fundamentals. The SE concept provides a basis for rational-expectations models of excess market volatility. The best way to analyze bank runs and related financial fragilities is as a sunspot equilibrium outcome in the pre-deposit game. The current financial meltdown is largely financial and partly sunspot driven. Sunspots can improve resource allocation in non-convex and incentive-constratined economies.
Any one of the following departures from the basic Walrasian model allows there to be proper sunspot equilibria:
- The “double infinity” of consumers and dated commodities (as naturally arise in infinite-horizon OG models). See Shell JPE (1971), Shell (1977) and Cass and Shell (1989).
- Restrictions on market participation (as naturally arise in OG models). See Shell (1977) and Cass and Shell (1983).
- Incomplete markets (as naturally arise in OG models and elsewhere). See Shell (1977) and the work of David Cass and others.
- Asymmetric information. See Peck and Shell (1985, 1991) and Aumann, Peck and Shell (1988). See also mechanism design problems such as Peck and Shell (2003, 2010).
- Imperfect competition (as modeled, e.g. by market games). See Peck and Shell (1985, 1991).
- Consumption or production externalities, as introduced by Steve Spear and successfully explored in applied work on economic fluctuations by Jess Benhabib, Roger Farmer, Stephanie Schmitt-Grohé, Yi Wen, Pengfei Wang, and others.
- Nonconvexities in consumption or production. See Shell and Wright (1993) Goenka and Shell (1997), and Garratt, Keister, Qin, and Shell (2002), and Garratt, Keister, and Shell (2004).
- Monetary indeterminacy. See Bhattacharya, Guzman and Shell (1998) for a very simple model that elucidates “the fundamental source of sunspot equilibria”.
- “Monnaie et allocation intertemporelle” [title and abstract in French, text in English] mimeo., Séminaire Roy-Malinvaud, Centre National de la Recherche Scientifique, Paris, November 21, 1977. To be published in Macroeconomic Dynamics as a Vintage Unpublished Paper.
- “Les tâches solaires ont-elles de l’importance?” (with David Cass), Cahiers du séminaire d’économétrie, 24, 1982, 93-127. This is slightly more general than the JPE version.
- “Do Sunspots Matter?” (with David Cass), Journal of Political Economy, Vol. 91(2), April 1983, 193-227. Reprinted in General Equilibrium Theory (G. Debreu, ed.), The International Library of Critical Writings in Economics 67, London: Edgar Elgar Publishing, 1996, Vol. I, Chapter 17, 295-329.
- “Market Uncertainty: Sunspot Equilibria in Imperfectly Competitive Economies” (with James Peck), Working Paper 85-21, Center for Analytic Research in Economics and the Social Sciences, University of Pennsylvania, Philadelphia, July 1985. This is more complete than the RES version.
- “Sunspot Equilibrium” in The New Palgrave: A Dictionary of Economics (J. Eatwell, M. Milgate, and P. Newman, eds.), Vol. 4, New York: Macmillan, 1987, 549-551. Reprinted in The New Palgrave: General Equilibrium (J. Eatwell, M. Milgate, and P. Newman, eds.), New York: Macmillan, 1989, 274-280.
- “Asymmetric Information and Sunspot Equilibria: A Family of Simple Examples” (with Robert J. Aumann and James Peck), Working Paper 88-34, Center for Analytic Economics, Cornell University, Ithaca, October 1988.
- “Sunspot Equilibrium in an Overlapping-Generations Economy with an Idealized Contingent-Commodities Market” (with David Cass), Part 1, Chapter 1 in Economic Complexity: Chaos, Sunspots, Bubbles, and Nonlinearity (W. Barnett, J. Geweke, and K. Shell, eds.), New York: Cambridge University Press, 1989, 3-20.
- “On the Nonequivalence of the Arrow-Securities Game and the Contingent-Commodities Game” (with James Peck), Part 1, Chapter 4 in Economic Complexity: Chaos, Sunspots, Bubbles, and Nonlinearity (W. Barnett, J. Geweke, and K. Shell, eds.), New York: Cambridge University Press, 1989, 61-85.
- “Market Uncertainty: Correlated and Sunspot Equilibria in Imperfectly Competitive Economies” (with James Peck), The Review of Economic Studies, Vol. 58(5), October 1991, 1011-1029.
- “Sunspot Equilibrium” (with Bruce D. Smith), in the New Palgrave Dictionary of Money and Finance (J. Eatwell, M. Milgate, and P. Newman, eds.), Vol. 3, London: Macmillan, 1992, 601-605.
- “Indivisibilities, Lotteries, and Sunspot Equilibria” (with Randall D. Wright), Economic Theory, Vol. 3(1), January 1993, 1-17.
- “Sunspot Equilibrium” Jacob Marschak Colloquium at UCLA, November 13, 1992, abstract in Mathematical Social Sciences, Vol. 26, July 1993, 101.
- “Further Evidence of the Necessity of Sunspots” (with Rod J. Garratt), Working Paper in Economics 6-93, Department of Economics, University of California, Santa Barbara, April 1993.
- “Market Participation and Sunspot Equilibria” (with Yves Balasko and David Cass), The Review of Economic Studies, Vol. 62(3), No. 212, July 1995, 491-512. Reprinted in Equilibrium (D. Walker, ed.), Critical Ideas in Economics Volume 3, London: Edward Elgar, 2000, 591-615.
- “When Sunspots Don’t Matter” (with Aditya Goenka), Economic Theory, Vol. 9(1), January 1997, 169-178.
- “Robustness of Sunspot Equilibria” (with Aditya Goenka), Economic Theory, Vol. 10(1), July 1997, 79-98.
- “Price Level Volatility: A Simple Model of Money Taxes and Sunspots” (with Joydeep Bhattacharya and Mark Guzman), Journal of Economic Theory, Vol. 81(2), August 1998, 401-430. (doi:10.1006/jeth.1997.2362)
- “Introduction to Sunspots and Lotteries” (with Edward C. Prescott), Journal of Economic Theory, Vol. 107(1), November 2002, 1-10. (doi:10.1006/jeth.2002.2946)
- “Equilibrium Prices when the Sunspot Variable is Continuous” (with Rod Garratt, Todd Keister, and Cheng-Zon Qin), Journal of Economic Theory, Vol. 107(1), November 2002, 11-38. (doi:10.1006/jeth.1999.2634)
- “Equilibrium Bank Runs” (with James Peck), Journal of Political Economy, Vol. 111(1), February 2003, 103-123.
- “Comparing Sunspot Equilibrium and Lottery Equilibrium Allocations: The Finite Case” (with Rod Garratt and Todd Keister), International Economic Review, Vol.45(2), May 2004, 351-386. (doi: 10.1111/j.1486-2354.2004.00129.x)
- “General Equilibrium with Nonconvexities and Money” (with Guillaume Rocheteau, Peter Rupert, and Randall Wright), Journal of Economic Theory, Vol. 142(1), September 2008, 294-317.
- “Sunspot Equilibrium”, The New Palgrave: A Dictionary of Economics, 2nd Edition (L. Blume and S. Durlauf, eds.), New York: Palgrave Macmillan, 2008. Also at The New Palgrave Dictionary of Economics Online. 03 June 2009.
- “Could Making Banks Hold Only Liquid Assets Induce Bank Runs?” (with James Peck), Journal of Monetary Economics, Vol 7:4, May 2010.
- “Winners and Losers from Price-Level Volatility: Money Taxation and Information Frictions”(with Guido Cozzi, Aditya Goenka, and Minwook Kang), CAE Working Paper #15-01, July 2015.
- “Price Level Volatility and Optimal Taxation” (with Guido Cozzi, Aditya Goenka, and Minwook Kang), September 2015.
- “Bank Runs: The Pre-Deposit Game” (with Yu Zhang), Macroeconomic Dynamics, forthcoming. (Online Appendices)
- “Price-Level Volatility, Optimal Taxation and Voting” (with Guido Cozzi, Aditya Goenka, and Minwook Kang), April 2016