A Welfare Criterion with Endogenous Welfare Weights for Belief Disagreement Models

While belief disagreement models have played an important role in explaining bubbles, over-trading, and speculation, measuring social welfare in those models has been a challenge. This is because the social planner may not know the objective probabilities or whose subjective beliefs to elect under belief disagreements. We propose a novel welfare criterion that endogenously determines sensible welfare weights based on competitive equilibrium allocation as a benchmark. Applying it to several models with heterogeneous beliefs, we show how regulation in moderation, rather than tight control of the market, can be optimal even in the presence of heterogeneous beliefs.