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Rational Overconfidence and Social Security

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  • Carsten Krabbe Nielsen

    ()
    (Istituto Politica Economica, Universita Cattolica and Korea University)

Abstract

Two of the features that distinguish Social Security and many other state mandated pension plans around the world are that (i) a minimum level of savings for retirement is imposed on most citizens and (ii) individuals cannot decide how their contributions are invested. Here, a rationale for these two features, based on ratoinal overconfidence, is proposed. Rational overconfidence is present when equally informed agents hold diverse confident, rational beliefs. The fact that beliefs are diverse means that all of them cannot be correct, hence seen as a collective agents do not act optimally. In the face of rational overconfidence, Pareto efficiency is no long the natural criterion for comparing policies and we suggest ex-post welfare optimality instead. This criterion makes amends for the possible inconsistencies of agents beliefs. Our results on social security are based on a methodology that places itself strictly between the traditional neoclassical approach and that championed by behavioral economics. This methodology does not deviate from the neoclassical assumption of ratoinality but only broadens it and can therefore readily be applied to many public policy issues.

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Bibliographic Info

Paper provided by Institute of Economic Research, Korea University in its series Discussion Paper Series with number 0916.

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Length: 29 pages
Date of creation: 2009
Date of revision:
Handle: RePEc:iek:wpaper:0916

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Keywords: Subjective Expectations; Rational Beliefs; Ex-post Welfare Optimality; Social Security; Rational Overconfidence; Portfolio Choice;

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References

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  1. William A. Branch, 2004. "The Theory of Rationally Heterogeneous Expectations: Evidence from Survey Data on Inflation Expectations," Economic Journal, Royal Economic Society, vol. 114(497), pages 592-621, 07.
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  5. Nielsen, Carsten Krabbe, 2008. "On rationally confident beliefs and rational overconfidence," Mathematical Social Sciences, Elsevier, vol. 55(3), pages 381-404, May.
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  10. Souleles, Nicholas S, 2004. "Expectations, Heterogeneous Forecast Errors, and Consumption: Micro Evidence from the Michigan Consumer Sentiment Surveys," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 36(1), pages 39-72, February.
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  13. Varian, Hal R, 1985. " Divergence of Opinion in Complete Markets: A Note," Journal of Finance, American Finance Association, vol. 40(1), pages 309-17, March.
  14. Carsten Nielsen, 2009. "Non-stationary, stable Markov processes on a continuous state space," Economic Theory, Springer, vol. 40(3), pages 473-496, September.
  15. Carsten Krabbe Nielsen, 2003. "Floating exchange rates versus a monetary union under rational beliefs: the role of endogenous uncertainty," Economic Theory, Springer, vol. 21(2), pages 293-315, 03.
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  20. Carsten Krabbe Nielsen, 1995. "Rational Belief Structures and Rational Belief Equilibrium," Discussion Papers 95-14, University of Copenhagen. Department of Economics.
  21. Baak, Saang Joon, 1999. "Tests for bounded rationality with a linear dynamic model distorted by heterogeneous expectations," Journal of Economic Dynamics and Control, Elsevier, vol. 23(9-10), pages 1517-1543, September.
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Citations

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Cited by:
  1. Peter J. Hammond, 2013. "Extending the Original Position: Revisiting the Pattanaik Critique of Vickrey/Harsanyi Utilitarianism," Global COE Hi-Stat Discussion Paper Series gd12-298, Institute of Economic Research, Hitotsubashi University.
  2. Carsten Nielsen, 2011. "Price stabilizing, Pareto improving policies," Economic Theory, Springer, vol. 47(2), pages 459-500, June.

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