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Lotteries, Sunspots, and Incentive Constraints

Timothy J. Kehoe, David K. Levine, and Edward C. Prescott

September 11, 1997

Revised: August 22, 1998

Abstract: We study a prototypical class of exchange economies with private information and indivisibilities. We establish an equivalence between lottery equilibria and sunspot equilibria and show that the welfare and existence theorems hold. To establish these results we introduce the concept of the stand-in consumer economy, which is a standard convex, finite consumer, finite good, pure exchange economy. With decreasing absolute risk aversion and no indivisibilities, we show that no lotteries are actually used in equilibrium.