Sunspots and Multiplicity

This paper proves that, in a general financial model with incomplete markets, the multiplicity of certainty equilibria is not necessary for the existence of sunspot effects. These effects are present, by definition, when real economic variables differ across realizations of extrinsic uncertainty. In a financial model of incomplete markets with identical payouts across realizations of extrinsic uncertainty, the past literature has concluded that multiplicity of certainty equilibria is necessary for sunspot effects. However, all these papers model extrinsic uncertainty using expected utility. In this paper, I consider a generalization of expected utility, a form that Dave Cass labeled UBU (utility-based utility). With this form, my result proves that the class of rational expectations equilibria exhibiting sunspot effects is much broader than the class of multiple certainty equilibria. JEL Classifications: D61; D81; D91