The Value of Future Earnings in Perfect Foresight Equilibrium

Abstract

The present work considers the problem of valuing a future income stream in a perfect foresight economy. In this setting, with competitive equilibrium in labor and asset markets, market valuation of labor-generated income streams can be very simple. However, it can also be undone by moral hazard, in which case valuation may be based instead on fair compensation. I show that perfect foresight valuation emerges somewhat imperfectly in the forensic economics literature. To apply this type of valuation, the economist must form an expectation E[P] about perfect foresight price P. I consider several models of this expectation, some of which yield standard present value equations. I find that, while standard equations “fit” historical data well in some respects, they miss some dynamics that are better captured by more advanced econometric methods.