Dynamic beliefs

Rosario Macera

Games and Economic Behavior, 2014, vol. 87, issue C, 1-18

Abstract: This paper studies the temporal path of subjective probability assessments. A reference-dependent agent who experiences utility from anticipation and from changes in this anticipatory emotion makes utility-maximizing assessments about his likelihood of success in a future lottery. Consistent with the empirical evidence, the model predicts that if the lottery is sufficiently valuable, optimism decreases as the payoff date approaches. Intuitively, as time goes by, last-period expected disappointment becomes increasingly important relative to the joy of anticipating a favorable outcome. Applying the model to the optimal timing of productivity bonuses, I find that a decreasing path of beliefs reduces the cost of providing incentives. Thus, optimal bonuses are sizable and are not frequently offered.

Keywords: Optimal beliefs; Anticipatory utility; Reference-dependent utility; Bonuses; Incentives (search for similar items in EconPapers)
JEL-codes: D03 D81 D84 J33 (search for similar items in EconPapers)
Date: 2014
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:gamebe:v:87:y:2014:i:c:p:1-18

DOI: 10.1016/j.geb.2014.05.003

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