A Welfare Criterion For Models With Distorted Beliefs

This paper proposes a welfare criterion for economies in which agents have heterogeneously distorted beliefs. Instead of taking a stand on whose belief is correct, our criterion asserts that an allocation is belief-neutral efficient (inefficient) if it is efficient (inefficient) under any convex combination of agents' beliefs. While this criterion gives an incomplete ranking of social allocations, it can identify positiveand negative-sum speculation driven by conflicting beliefs in a broad range of economic environments. Markus K. Brunnermeier Princeton University Department of Economics Bendheim Center for Finance Princeton, NJ 08540 and NBER [email protected] Alp Simsek Department of Economics, E17-244 MIT 77 Massachusetts Avenue Cambridge, Ma. 02139 and NBER [email protected] Wei Xiong Princeton University Department of Economics Bendheim Center for Finance Princeton, NJ 08450 and NBER [email protected]