Believing in forecasts, uncertainty, and rational expectations

Efe A. Ok () and Andrei Savochkin
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Efe A. Ok: New York University

Economic Theory, 2022, vol. 74, issue 3, No 9, 947-971

Abstract: Abstract We model situations of choice under uncertainty where one is exogenously given information about the unknown states as a “suggested prior” (as in weather forecasts, betting odds provided by bookmakers, success likelihoods provided by medical doctors, estimates given by financial analysts, etc.). We wish to understand when a decision maker would adopt the suggested prior as her own subjective beliefs, yielding fully to the power of suggestion. We find that this happens under surprisingly weak conditions: If a preference relation, may it be complete or incomplete, (1) uses the information it is given consistently (in the sense of being state-neutral) and (2) believes that events that are suggested to occur with zero probability will indeed not occur, then it is not only probabilistically sophisticated, but also holds the suggested beliefs as actual beliefs. If the agent is a (subjective) expected utility maximizer, this happens even in the absence of condition (2).

Keywords: Probabilistic sophistication; Power of suggestion; Rational expectations; Distortion of probabilities (search for similar items in EconPapers)
JEL-codes: D11 D81 D83 (search for similar items in EconPapers)
Date: 2022
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DOI: 10.1007/s00199-021-01387-0

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