Twisting the Truth: Foundations of Wishful Thinking

40 Pages Posted: 15 May 2018

See all articles by Matthew Kovach

Matthew Kovach

Virginia Polytechnic Institute & State University - Department of Economics

Date Written: May 1, 2018

Abstract

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

Kovach, Matthew, Twisting the Truth: Foundations of Wishful Thinking (May 1, 2018). Available at SSRN: https://ssrn.com/abstract=3171393 or http://dx.doi.org/10.2139/ssrn.3171393

Matthew Kovach (Contact Author)

Virginia Polytechnic Institute & State University - Department of Economics ( email )

3016 Pamplin Hall (0316)
880 West Campus Drive
Blacksburg, VA 24061
United States

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