Sunspot equilibria and periodic cycles under idiosyncratic uncertainty

Abstract

This paper investigates how some intrinsic uncertainty affects the existence of sunspot equilibria and deterministic cycles in an overlapping generations model. In the model, there exists an intrinsic idiosyncratic uncertainty under which each individual has a small probability of losing consumption goods. Due to the law of large numbers, this uncertainty causes no fundamental macroeconomic fluctuation. However, since it may change the dynamic stability, the model may have both stationary sunspot equilibria and deterministic cycles even if the degree of relative risk aversion is small. In particular, these equilibria can exist even if the probability of loss is negligible.