IDEAS home Printed from https://ideas.repec.org/p/cpr/ceprdp/4656.html
   My bibliography  Save this paper

Optimal Expectation

Author

Listed:
  • Brunnermeier, Markus K
  • Parker, Jonathan A

Abstract

This Paper introduces a tractable, structural model of subjective beliefs. Forward-looking agents care about expected future utility flows, and hence have higher current felicity if they believe that better outcomes are more likely. On the other hand, biased expectations lead to poorer decisions and worse realized outcomes on average. Optimal expectations balance these forces by maximizing average felicity. A small bias in beliefs typically leads to first-order gains due to increased anticipatory utility and only to second-order costs due to distorted behaviour. We show that in a portfolio choice problem, agents overestimate the return on their investment and exhibit a preference for skewness. In general equilibrium, agents’ prior beliefs are endogenously heterogeneous. Finally, in a consumption-saving problem with stochastic income, agents are both overconfident and overoptimistic.

Suggested Citation

  • Brunnermeier, Markus K & Parker, Jonathan A, 2004. "Optimal Expectation," CEPR Discussion Papers 4656, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:4656
    as

    Download full text from publisher

    File URL: http://www.cepr.org/active/publications/discussion_papers/dp.php?dpno=4656
    Download Restriction: CEPR Discussion Papers are free to download for our researchers, subscribers and members. If you fall into one of these categories but have trouble downloading our papers, please contact us at subscribers@cepr.org

    As the access to this document is restricted, you may want to look for a different version below or search for a different version of it.

    Other versions of this item:

    References listed on IDEAS

    as
    1. Robert B. Barsky & Miles S. Kimball & F. Thomas Juster & Matthew D. Shapiro, 1995. "Preference Parameters and Behavioral Heterogeneity: An Experimental Approach in the Health and Retirement Survey," NBER Working Papers 5213, National Bureau of Economic Research, Inc.
    2. Akerlof, George A & Dickens, William T, 1982. "The Economic Consequences of Cognitive Dissonance," American Economic Review, American Economic Association, vol. 72(3), pages 307-319, June.
    3. Roland Bénabou & Jean Tirole, 2002. "Self-Confidence and Personal Motivation," The Quarterly Journal of Economics, Oxford University Press, vol. 117(3), pages 871-915.
    4. Robert B. Barsky & F. Thomas Juster & Miles S. Kimball & Matthew D. Shapiro, 1997. "Preference Parameters and Behavioral Heterogeneity: An Experimental Approach in the Health and Retirement Study," The Quarterly Journal of Economics, Oxford University Press, vol. 112(2), pages 537-579.
    5. Andrew Caplin & John Leahy, 2001. "Psychological Expected Utility Theory and Anticipatory Feelings," The Quarterly Journal of Economics, Oxford University Press, vol. 116(1), pages 55-79.
    6. Leeat Yariv, 2002. "I'll See It When I Believe It - A Simple Model of Cognitive Consistency," Cowles Foundation Discussion Papers 1352, Cowles Foundation for Research in Economics, Yale University.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    belief biases; consumption; expectation; gambling; heterogenous beliefs; overconfidence; portfolio choice; saving;

    JEL classification:

    • D10 - Microeconomics - - Household Behavior - - - General
    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:cpr:ceprdp:4656. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (). General contact details of provider: .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.