IDEAS home Printed from https://ideas.repec.org/p/cda/wpaper/68.html
   My bibliography  Save this paper

Anticipated Utility and Rational Expectations as Approximations of Bayesian Decision Making

Author

Listed:
  • Tim W. Cogley
  • Thomas J. Sargent

    (Department of Economics, University of California Davis)

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.

Suggested Citation

  • Tim W. Cogley & Thomas J. Sargent, 2005. "Anticipated Utility and Rational Expectations as Approximations of Bayesian Decision Making," Working Papers 68, University of California, Davis, Department of Economics.
    • Handle: RePEc:cda:wpaper:68
    as

    Download full text from publisher

    File URL: https://repec.dss.ucdavis.edu/files/9awFRHTxezcix7t2qssZ4YY3/05-23.pdf
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Hall, Robert E, 1978. "Stochastic Implications of the Life Cycle-Permanent Income Hypothesis: Theory and Evidence," Journal of Political Economy, University of Chicago Press, vol. 86(6), pages 971-987, December.
    2. Watson, Mark W, 1993. "Measures of Fit for Calibrated Models," Journal of Political Economy, University of Chicago Press, vol. 101(6), pages 1011-1041, December.
    3. Abel, Andrew B., 2002. "An exploration of the effects of pessimism and doubt on asset returns," Journal of Economic Dynamics and Control, Elsevier, vol. 26(7-8), pages 1075-1092, July.
    4. Hansen, Lars Peter & Jagannathan, Ravi, 1991. "Implications of Security Market Data for Models of Dynamic Economies," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 225-262, April.
    5. Kenneth L. Judd, 1998. "Numerical Methods in Economics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262100711, April.
    6. Cogley, Timothy & Morozov, Sergei & Sargent, Thomas J., 2005. "Bayesian fan charts for U.K. inflation: Forecasting and sources of uncertainty in an evolving monetary system," Journal of Economic Dynamics and Control, Elsevier, vol. 29(11), pages 1893-1925, November.
    7. Pok-sang Lam & Stephen G. Cecchetti & Nelson C. Mark, 2000. "Asset Pricing with Distorted Beliefs: Are Equity Returns Too Good to Be True?," American Economic Review, American Economic Association, vol. 90(4), pages 787-805, September.
    8. Jacobs,Donald P. & Kalai,Ehud & Kamien,Morton I. & Schwartz,Nancy L. (ed.), 1998. "Frontiers of Research in Economic Theory," Cambridge Books, Cambridge University Press, number 9780521635387, September.
    9. Sargent, Thomas J., 1993. "Bounded Rationality in Macroeconomics: The Arne Ryde Memorial Lectures," OUP Catalogue, Oxford University Press, number 9780198288695.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Timothy Cogley & Thomas J. Sargent, 2008. "Anticipated Utility And Rational Expectations As Approximations Of Bayesian Decision Making," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 49(1), pages 185-221, February.
    2. Nengjiu Ju & Jianjun Miao, 2012. "Ambiguity, Learning, and Asset Returns," Econometrica, Econometric Society, vol. 80(2), pages 559-591, March.
    3. Tim W. Cogley & Thomas J. Sargent, 2005. "The Market Price of Risk and the Equity Premium," Working Papers 55, University of California, Davis, Department of Economics.
    4. Calvet, Laurent-Emmanuel & Grandmont, Jean-Michel & Lemaire, Isabelle, 2018. "Aggregation of heterogenous beliefs, asset pricing, and risk sharing in complete financial markets," Research in Economics, Elsevier, vol. 72(1), pages 117-146.
    5. Tim W. Cogley & Thomas J. Sargent, 2005. "The Market Price of Risk and the Equity Premium," Working Papers 522, University of California, Davis, Department of Economics.
    6. Gurdip Bakshi, 2009. "Du subjectiv expectations explain asset pricing puzzles?," 2009 Meeting Papers 1234, Society for Economic Dynamics.
    7. Hansen, Lars Peter, 2013. "Risk Pricing over Alternative Investment Horizons," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, volume 2, chapter 0, pages 1571-1611, Elsevier.
    8. Cogley, Timothy & Sargent, Thomas J., 2008. "The market price of risk and the equity premium: A legacy of the Great Depression?," Journal of Monetary Economics, Elsevier, vol. 55(3), pages 454-476, April.
    9. Raghu Suryanarayanan, 2006. "Implications of Anticipated Regret and Endogenous Beliefs for Equilibrium Asset Prices: A Theoretical Framework," CSEF Working Papers 162, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
    10. Gabaix, Xavier, 2015. "Behavioral Macroeconomics Via Sparse Dynamic Programming," CEPR Discussion Papers 11026, C.E.P.R. Discussion Papers.
    11. Rhys Bidder & Ian Dew-Becker, 2016. "Long-Run Risk Is the Worst-Case Scenario," American Economic Review, American Economic Association, vol. 106(9), pages 2494-2527, September.
    12. Axioglou Christos & Skouras Spyros, 2015. "Asset pricing with flexible beliefs," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 19(4), pages 415-443, September.
    13. repec:bla:jecsur:v:16:y:2002:i:3:p:301-55 is not listed on IDEAS
    14. Borovička, Jaroslav & Hansen, Lars Peter, 2014. "Examining macroeconomic models through the lens of asset pricing," Journal of Econometrics, Elsevier, vol. 183(1), pages 67-90.
    15. Miao, Jianjun & Wang, Neng, 2007. "Investment, consumption, and hedging under incomplete markets," Journal of Financial Economics, Elsevier, vol. 86(3), pages 608-642, December.
    16. Emilio Fernandez-Corugedo, 2004. "Consumption Theory," Handbooks, Centre for Central Banking Studies, Bank of England, number 23, April.
    17. Bill Dupor, 2002. "The Natural Rate of Q," American Economic Review, American Economic Association, vol. 92(2), pages 96-101, May.
    18. John Stachurski, 2009. "Economic Dynamics: Theory and Computation," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262012774, April.
    19. Ludwig, Alexander & Zimper, Alexander, 2014. "Biased Bayesian learning with an application to the risk-free rate puzzle," Journal of Economic Dynamics and Control, Elsevier, vol. 39(C), pages 79-97.
    20. Isaac Kleshchelski & Nicolas Vincent, 2007. "Robust Equilibrium Yield Curves," Cahiers de recherche 08-02, HEC Montréal, Institut d'économie appliquée.
    21. Carl Chiarella & Roberto Dieci & Xue-Zhong He, 2006. "Aggregation of Heterogeneous Beliefs and Asset Pricing Theory: A Mean-Variance Analysis," Research Paper Series 186, Quantitative Finance Research Centre, University of Technology, Sydney.

    More about this item

    Keywords

    Rational expectations; Bayes? Law; anticipated utility; market price ofrisk;
    All these keywords.

    JEL classification:

    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations

    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:cda:wpaper:68. See general information about how to correct material in RePEc.

    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 bibliographic 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.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Letters and Science IT Services Unit (email available below). General contact details of provider: https://edirc.repec.org/data/educdus.html .

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

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.