Optimal expectations
By: Markus K. Brunnermeier, Jonathan A. Parker.
Contributors: Parker, Jonathan A.; National Bureau of Economic Research.
Series: NBER working paper series ;; working paper 10707; Working paper series (National Bureau of Economic Research : Online) ;; working paper no. 10707.
Publisher: National Bureau of Economic Research
Published: 2004
Place of publication: Cambridge, MA
Language: eng
Format: Electronic resource
Subjects: Consumer confidence -- Mathematical models.; Rational expectations (Economic theory) -- Mathematical models.; Decision making -- Mathematical models.
Description: "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 behavior.  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"--National Bureau of Economic Research web site.
Notes: Includes bibliographical references.
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