Essays in Behavioral Dynamics

Abstract

This thesis consists of three chapters that study behavior when people make correct inferences from observed events but make mistakes when reasoning about hypothetical events. This type of behavior is documented in a growing experimental literature on failures of contingent thinking. The first chapter proposes a theoretical framework for analyzing this behavior in competitive markets, introducing Dynamic Cursed Expectations (DCE) and the corresponding equilibrium concept, Dynamic Cursed Expectations Equilibrium (DCEE). The second chapter studies an asset pricing model and shows that DCEE leads to overvaluation of risky assets and overtrading relative to the Rational Expectations Equilibrium benchmark. The third chapter introduces Sequential Cursed Equilibrium (SCE) for extensive games and shows that multiple experimental results on failures of contingent thinking can be explained by SCE behavior.