Anticipated Utility and Rational Expectations as Approximations of Bayesian Decision Making

Timothy Cogley () and Thomas Sargent ()

Working Papers from University of California at Davis, Department of Economics

Abstract: For a Markov decision problem in which unknown transition probabilities serve as hidden state variables, we study the quality of two approximations to the decision rule of a Bayesian who each period updates his subjective distribution over the transition probabilities by Bayes' law. The first is the usual rational expectations approximation that assumes that the decision maker knows the transition probabilities. The second approximation is a version of Kreps' (1998) anticipated utility model in which decision makers update using Bayes' law but optimize in a way that is myopic with respect to their updating of probabilities. For a range of consumption smoothing examples, the anticipated utility approximation outperforms the rational expectations approximation. The anticipated utility and Bayesian models augment market prices of risk relative to the rational expectations approximation.

Date: 2005-03
View list of references View citations in EconPapers

Downloads: (external link)
http://www.econ.ucdavis.edu/working_papers/05-23.pdf

Related works:
Journal Article: ANTICIPATED UTILITY AND RATIONAL EXPECTATIONS AS APPROXIMATIONS OF BAYESIAN DECISION MAKING (2008)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: http://EconPapers.repec.org/RePEc:ecl:ucdeco:05-23

Access Statistics for this paper

More papers in Working Papers from University of California at Davis, Department of Economics
Contact information at EDIRC.
Series data maintained by ().