Options and Sunspots in a Simple Monetary Economy
Washington University in Saint Louis - Department of Economics
January 20, 1997
Economic Theory, Vol. 11, No. 2, 1998
We study sunspot immunity in a dynamic monetary economy in which consumers are allowed to trade put and call option contracts on the general price level. We define the concept of strong sunspot immunity to characterize economies that have no sunspot equilibria regardless of the number of extrinsic states and their probabilities of occurrence. We show that a small number of option contracts can make an economy strongly sunspot immune. In addition, we demonstrate how asset re-trading opportunities, and the associated capital gains and losses, reduce the number of options needed for this result to obtain.
Keywords: options, volatility, sunspot immunity
JEL Classification: D52, D84, E62, G10Accepted Paper Series
Date posted: July 30, 2012
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