Abstract:
This paper develops an approach to study predictions independent from the exact psychological cause of behavioral mistakes. In a canonical intertemporal consumption problem, I show how anticipation of future mistakes, by itself, explains key deviations from the permanent income hypothesis. The result provides a potential explanation of the empirical puzzle on high liquidity consumers’ high marginal propensities to consume (MPCs) and violations of the fungibility principle. I also illustrate how my framework can accommodate most widely-studied behavioral biases, such as inattention, mental accounting, rules of thumb, and hyperbolic discounting.
Link to paper (pdf).
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