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Dynamic beliefs

Author

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  • Macera, Rosario
Abstract
This paper studies the temporal path of subjective probability assessments. A reference-dependent agent who experiences utility from anticipation and from changes in this anticipatory emotion makes utility-maximizing assessments about his likelihood of success in a future lottery. Consistent with the empirical evidence, the model predicts that if the lottery is sufficiently valuable, optimism decreases as the payoff date approaches. Intuitively, as time goes by, last-period expected disappointment becomes increasingly important relative to the joy of anticipating a favorable outcome. Applying the model to the optimal timing of productivity bonuses, I find that a decreasing path of beliefs reduces the cost of providing incentives. Thus, optimal bonuses are sizable and are not frequently offered.

Suggested Citation

  • Macera, Rosario, 2014. "Dynamic beliefs," Games and Economic Behavior, Elsevier, vol. 87(C), pages 1-18.
    • Handle: RePEc:eee:gamebe:v:87:y:2014:i:c:p:1-18
    DOI: 10.1016/j.geb.2014.05.003
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    References listed on IDEAS

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    Cited by:

    1. Au, Pak Hung, 2016. "Price reaction and disagreement over public signal," Journal of Economic Behavior & Organization, Elsevier, vol. 130(C), pages 81-106.

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    More about this item

    Keywords

    Optimal beliefs; Anticipatory utility; Reference-dependent utility; Bonuses; Incentives;
    All these keywords.

    JEL classification:

    • D03 - Microeconomics - - General - - - Behavioral Microeconomics: Underlying Principles
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods

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