Boundedly Rational Dynamic Programming: Some Preliminary Results
New York University - Stern School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)
CEPR Discussion Paper No. DP8813
A key open question in economics is the practical, portable modeling of bounded rationality. In this short note, I report on ongoing progress that is more fully developed elsewhere. I present some results from a new model with boundedly rational features in which the decision-maker (DM) builds a simplified representation of the world. The model allows to model boundedly rational dynamic programming in a parsimonious and quite tractable way. I illustrate the approach via a boundedly rational version of the consumption-saving life cycle problem. The consumer can pay attention to the variables such as the interest rate and his income, or replace them, in his mental model, by their average values. Endogenously, the consumer pays little attention to interest rate but pays keen attention to his income. One consequence of this is that Euler equations will be biased, and the intertemporal elasticity of substitution will be biased toward 0, in a manner that is quantitatively important.
Keywords: behavioral economics, bounded rationality, inattention, intertemporal elasticity of substitution
JEL Classification: D03, E21working papers series
Date posted: March 1, 2012
© 2013 Social Science Electronic Publishing, Inc. All Rights Reserved.
This page was processed by apollo3 in 0.328 seconds