Endogenous Sunspots, Pseudo-bubbles, and Beliefs About Beliefs

We analyze a simple sunspot model that represents a standard securities market without sidebets on an exogenous sunspot event. The multiple self–fulfilling equilibria that arise in the model are based on investors’ uncertainty about other investors’ beliefs. Hence, these multiple equilibria are “endogenous sunspots.” We show that endogenous sunspots can arise even with complete markets to which all investors have access and homogeneous beliefs, provided the homogeneity is not common knowledge. We also show that endogenous sunspots can produce “pseudo–bubbles” in which the risky asset price is higher (or lower) at all dates than in a no–sunspot equilibrium. JEL Classification Codes: D84, G12