Dynamic beliefs

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2 Scopus citations

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.

Original languageEnglish
Pages (from-to)1-18
Number of pages18
JournalGames and Economic Behavior
Volume87
DOIs
StatePublished - Sep 2014
Externally publishedYes

Keywords

  • Anticipatory utility
  • Bonuses
  • D03
  • D81
  • D84
  • Incentives
  • J33
  • Optimal beliefs
  • Reference-dependent utility

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