Abstract
This paper proposes a tractable way to model boundedly rational dynamic programming. The agent uses an endogenously simplified, or sparse, model of the world and the consequences of his actions and acts according to a behavioral Bellman equation. The framework yields a behavioral version of some of the canonical models in macroeconomics and finance. In the life-cycle model, the agent initially does not pay much attention to retirement and undersaves; late in life, he progressively saves more, generating realistic dynamics. In the consumption-savings model, the consumer decides to pay little or no attention to the interest rate and more attention to his income. Ricardian equivalence and the Lucas critique partially fail because the consumer may not pay full attention to taxes and policy changes. In a Merton-style dynamic portfolio choice problem, the agent endogenously pays limited or no attention to the varying equity premium and hedging demand terms. Finally, in the neoclassical growth model, agents act on a simplified model of the macroeconomy; in equilibrium, fluctuations are larger and more persistent.
Sign-in/Register to access full text options 
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a callDisclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.
