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Optimal
Expectations
| Co-author: |
Jonathan A. Parker
(Princeton University) |
| Reference: |
American Economic
Review (forthcoming), NBER Working Paper
10707. |
| Abstract: |
This paper
introduces a tractable, structural model of subjective beliefs.
Forward-looking agents care about expected future utility flows,
and hence have higher current felicity if they believe that better
outcomes are more likely. On the other hand, biased expectations
lead to poorer decisions and worse realized outcomes on average.
Optimal expectations balance these forces by maximizing average
felicity. A small bias in beliefs typically leads to first-order
gains due to increased anticipatory utility and only to
second-order costs due to distorted behavior. We show that in a
portfolio choice problem, agents overestimate the return on their
investment and exhibit a preference for skewness. In general
equilibrium, agents' prior beliefs are endogenously heterogeneous.
Finally, in a consumption-saving problem with stochastic income,
agents are both overconfident and overoptimistic. |
| Keywords: |
expectations, heterogeneous
beliefs, belief biases, consumption, saving, portfolio choice,
overconfidence, gambling |
| Presentation
Slides: |
PDF |
| Extra
Information: |
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