Optimal Beliefs in the Long Run

People have the natural tendency to be optimistic and believe that good outcomes in the future are more likely, but also want to avoid overestimation that could result in bad decision-making. Brunnermeier and Parker (2005, 2007) established an optimal beliefs framework that balances these two incentives. This paper follows and extends the optimal beliefs framework to consider optimal beliefs in the long run after successive generations. Assuming no short-selling, result shows that in almost all cases there does not exist a stable and interior long-term optimal belief. I would like to thank Professor Paulo Natenzon for his invaluable contributions and kind support as my thesis advisor. Without him I could not have completed my thesis. I would also like to thank Professor Sebastian Galiani, Professor Bruce Petersen, Professor Costas Azariadis, and Professor John Nachbar for all their assistance and much appreciated feedback. Finally, I would like to thank Professor Dorothy Petersen for allowing me to do an honors thesis.