We model agents who get utility from their beliefs and therefore interpret information optimistically. They may exhibit several biases observed in psychological studies such as optimism, procrastination, confirmation bias, polarization, and the endowment effect. In some formulations, they exhibit these biases even though they are subjectively Bayesian. We argue that wishful thinking can lead to reduced saving, can make possible information-based trade, and can generate asset bubbles.
We thank Anmol Bhandari, Stefano DellaVigna, Wouter den Haan, Behzad Diba, Jordi Gali, Nicola Pavoni, Kaitlin Raimi, Matthew Shapiro, Allen Sinai, Alp Simsek, Linda Tesar, Fabrizio Perri, Jaume Ventura, and Gianluca Violante for helpful discussions. We thank the Alfred P. Sloan and NOMIS Foundations for support. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
John V. Leahy
During the course of this work I consulted at the Research Department of the Federal Reserve Bank of Chicago (Chicago, IL) and the Center for Advanced Financial Research and Learning (Mumbai, India).