Dynamic beliefs |
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| Institution: | 1. Department of Government, University of Essex, Wivenhoe Park, Colchester CO4 3SQ, United Kingdom;2. Faculty of Engineering, Information and Systems, University of Tsukuba, 1-1-1 Tennodai, Tsukuba, Ibaraki 305-8573, Japan;3. WZB Berlin Social Science Center, Reichpietschufer 50, D-10785 Berlin, Germany;4. Department of Economics, University of Heidelberg, Bergheimer Str. 58, 69115 Heidelberg, Germany;1. University of Heidelberg, Germany;2. University of Amsterdam and Tinbergen Institute, The Netherlands;1. University of Cologne, Department of Economics, Albertus-Magnus Platz, D-50923 Cologne, Germany;2. Department of Economics, University of Essex, Wivenhoe Park, Colchester CO4 3SQ, United Kingdom |
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| 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. |
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| Keywords: | Optimal beliefs Anticipatory utility Reference-dependent utility Bonuses Incentives |
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