Optimal Expectations

Jonathan Parker and Markus Brunnermeier

No 426, Econometric Society 2004 North American Winter Meetings from Econometric Society

Abstract: This paper introduces a tractable, structural model of subjective beliefs. Since agents that plan for the future care about expected future utility flows, current felicity can be increased by believing that better outcomes are more likely. On the other hand, expectations that are biased towards optimism worsen decision making, leading to poorer realized outcomes on average. Optimal expectations balance these forces by maximizing the total well-being of an agent over time. We apply our framework of optimal expectations to three different economic settings. In a portfolio choice problem, agents overestimate the return of their investment and underdiversify. In general equilibrium, agents' prior beliefs are endogenously heterogeneous, leading to gambling. Second, in a consumption-saving problem with stochastic income, agents are both overconfident and overoptimistic, and consume more than implied by rational beliefs early in life. Third, in choosing when to undertake a single task with an uncertain cost, agents exhibit several features of procrastination, including regret, intertemporal preference reversal, and a greater readiness to accept commitment.

Keywords: expectations formation; beliefs; overconfidence (search for similar items in EconPapers)
JEL-codes: D1 D8 E21 G1 (search for similar items in EconPapers)
Date: 2004-08-11
New Economics Papers: this item is included in nep-cfn
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (13)

Downloads: (external link)
http://www.princeton.edu/~markus/research/papers/optimal_expectations.pdf main text (application/pdf)

Related works:
Journal Article: Optimal Expectations (2005)
Working Paper: Optimal Expectation (2004)
Working Paper: Optimal Expectations (2004)
Working Paper: Optimal expectations (2002)
Working Paper: Optimal Expectations (2002)
Working Paper: Optimal Expectations (2002)
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:ecm:nawm04:426

Access Statistics for this paper

More papers in Econometric Society 2004 North American Winter Meetings from Econometric Society Contact information at EDIRC.
Bibliographic data for series maintained by Christopher F. Baum ().