Twisting the Truth: Foundations of Wishful Thinking
40 Pages Posted: 15 May 2018
Date Written: May 1, 2018
Considerable evidence shows that people have optimistic beliefs about future outcomes. I present an axiomatic model of wishful thinking (WT), in which an endowed alternative, or status quo, influences the agent’s beliefs over states and thus induces such optimism. I introduce a behavioral axiom formalizing WT and derive a representation in which the agent overweights states in which the endowment provides a higher payoff. WT is a novel channel through which an endowment may influence choice behavior and provides a coherent explanation for a variety of observed behavior, including choice reversals among non-status quo alternatives when the status quo changes. Finally, I show that WT leads to inefficient risk sharing in an exchange economy and has several unique implications for the gap between willingness to accept and willingness to pay for endowed goods.
Keywords: Wishful Thinking, Status Quo Bias, Reference Dependence, Belief Distortions, Optimism
JEL Classification: D01, D11, D80, D81, D83
Suggested Citation: Suggested Citation