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We analyze survey data for the U.S. and document a substantial optimistic bias of households in their subjective expectations about future labor market transitions. Using a heterogeneous agents life cycle model we show that the optimistic bias has a quantitatively sizable negative effect on the life cycle allocation of income, consumption and wealth and implies a substantial loss in individual welfare compared to the allocation under full information. Moreover, we establish that the heterogeneity in the bias leads to pronounced differences in the accumulation of assets across individuals, and is thereby a quantitatively important driver of wealth inequality.
