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"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.
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Optimal expectations
2002, Woodrow Wilson School of Public and International Affairs
Electronic resource
in English
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Book Details
Edition Notes
Also available in print.
Includes bibliographical references.
Title from home page (viewed on Mar. 12, 2004).
"December 2002."
System requirements: Adobe Acrobat Reader.
Mode of access: World Wide Web.
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