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Naiveté and sophistication in dynamic inconsistency

Author

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  • Peeters R.J.A.P.
  • Méder Z.Z.
  • Flesch J.

    (GSBE)

Abstract

This paper introduces a general framework for dealing with dynamic inconsistency in the context of Markov decision problems. It carefully decouples and examines concepts that are often entwined in the literature it distinguishes between the decision maker and its various temporal agents, and between the beliefs and intentions of the agents. Classical examples of naivet and sophistication are modeled and contrasted based on this new language. We show that naive and sophisticated decision makers can form optimal strategies at each possible history, and provide welfare comparisons for a class of decision problems including procrastination, impulsiveness, underinvestment, binges and indulgence. The creation of a unified formalism to deal with dynamic inconsistency allows for the introduction of a hybrid decision maker, who is naive sometimes, sophisticated at others. Such a hybrid decision maker can be used to model situations where type determination is endogenous. Interestingly, the analysis of hybrid types indicates that self-deception can be optimal.

Suggested Citation

  • Peeters R.J.A.P. & Méder Z.Z. & Flesch J., 2014. "Naiveté and sophistication in dynamic inconsistency," Research Memorandum 005, Maastricht University, Graduate School of Business and Economics (GSBE).
  • Handle: RePEc:unm:umagsb:2014005
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    File URL: https://cris.maastrichtuniversity.nl/portal/files/1719951/content
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    Cited by:

    1. Zhao, Qian & Wang, Rongming & Wei, Jiaqin, 2016. "Exponential utility maximization for an insurer with time-inconsistent preferences," Insurance: Mathematics and Economics, Elsevier, vol. 70(C), pages 89-104.

    More about this item

    Keywords

    Game Theory and Bargaining Theory: General; Consumer Economics: Theory; Intertemporal Consumer Choice; Life Cycle Models and Saving;

    JEL classification:

    • C70 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - General
    • D11 - Microeconomics - - Household Behavior - - - Consumer Economics: Theory
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making

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