General Equilibrium Dynamics with Naïve and Sophisticated Hyperbolic Consumers in an Overlapping Generations Economy

Using an overlapping generations model, this paper describes interactions between naïve and sophisticated hyperbolic discounters in general equilibrium. The naïfs, who overestimate their propensity to save and hence overforecast equilibrium asset prices, in the next period are exploited through capital transactions by the sophisticates, who correctly forecast future asset prices by incorporating the naïfs’ misforecasts. Due to the capital losses, the naïfs fall into bankruptcy when they are highly present‐biased, highly patient, and small in proportion. Under permissive conditions, the equilibrium is shown to be globally stable and Pareto‐inefficient in the ex post sense.