Anticipated Utility and Rational Expectations as Approximations of Bayesian Decision Making

Tim W. Cogley and Thomas Sargent

No 68, Working Papers from University of California, Davis, Department of Economics

Abstract: For a Markov decision problem in which unknown transition probabilitiesserve as hidden state variables, we study the quality of two approximations tothe decision rule of a Bayesian who each period updates his subjective distribu-tion over the transition probabilities by Bayes? law. The first is the usual ratio-nal expectations approximation that assumes that the decision maker knows thetransition probabilities. The second approximation is a version of Kreps? (1998)anticipated utility model in which decision makers update using Bayes? law butoptimize in a way that is myopic with respect to their updating of probabili-ties. For a range of consumption smoothing examples, the anticipated utilityapproximation outperforms the rational expectations approximation. The an-ticipated utility and Bayesian models augment market prices of risk relative tothe rational expectations approximation.

Keywords: Rational expectations; Bayes? Law; anticipated utility; market price ofrisk (search for similar items in EconPapers)
JEL-codes: C63 D83 D84 (search for similar items in EconPapers)
Pages: 46
Date: 2005-02-28
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

Downloads: (external link)
https://repec.dss.ucdavis.edu/files/9awFRHTxezcix7t2qssZ4YY3/05-23.pdf (application/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: https://EconPapers.repec.org/RePEc:cda:wpaper:68

Access Statistics for this paper

More papers in Working Papers from University of California, Davis, Department of Economics Contact information at EDIRC.
Bibliographic data for series maintained by Letters and Science IT Services Unit ().