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Uncertainty and compound lotteries: calibration

Author

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  • Yoram Halevy

    (University of Toronto
    Hebrew University of Jerusalem)

  • Emre Ozdenoren

    (London Business School)

Abstract

This paper introduces a theoretical model of decision making in which preferences are defined on both Savage subjective acts and compound objective lotteries. Preferences are two-stage probabilistically sophisticated when the ranking of acts corresponds to the ranking of the respective compound lotteries induced by the acts through the decision maker’s subjective belief. This family of preferences includes various theoretical models proposed in the literature to accommodate non-neutral attitude towards ambiguity. The principle of calibration relates preferences over acts and compound objective lotteries, and provides a foundation for the tight empirical association between probabilistic sophistication and reduction of compound lotteries for all two-stage probabilistically sophisticated preferences.

Suggested Citation

  • Yoram Halevy & Emre Ozdenoren, 2022. "Uncertainty and compound lotteries: calibration," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 74(2), pages 373-395, September.
    • Handle: RePEc:spr:joecth:v:74:y:2022:i:2:d:10.1007_s00199-022-01453-1
    DOI: 10.1007/s00199-022-01453-1
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    Cited by:

    1. Mohammed Abdellaoui & Peter Klibanoff & Lætitia Placido, 2015. "Experiments on Compound Risk in Relation to Simple Risk and to Ambiguity," Management Science, INFORMS, vol. 61(6), pages 1306-1322, June.
    2. Mohammed Abdellaoui & Aurelien Baillon & Laetitia Placido & Peter P. Wakker, 2011. "The Rich Domain of Uncertainty: Source Functions and Their Experimental Implementation," American Economic Review, American Economic Association, vol. 101(2), pages 695-723, April.
    3. Ozgur Evren, 2024. "Second-Order Representations: A Bayesian Approach," Working Papers w0291, New Economic School (NES).
    4. Evren, Özgür, 2019. "Recursive non-expected utility: Connecting ambiguity attitudes to risk preferences and the level of ambiguity," Games and Economic Behavior, Elsevier, vol. 114(C), pages 285-307.
    5. Roxane Bricet, 2018. "The price for instrumentally valuable information," THEMA Working Papers 2018-10, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise.
    6. Jianjun Miao, 2022. "Introduction to the special issue in honor of Larry Epstein," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 74(2), pages 329-333, September.
    7. Baillon, Aurélien & Driesen, Bram & Wakker, Peter P., 2012. "Relative concave utility for risk and ambiguity," Games and Economic Behavior, Elsevier, vol. 75(2), pages 481-489.

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    More about this item

    Keywords

    Ellsberg paradox; Ambiguity; Non-expected utility; Knightian uncertainty; Two-stage lotteries;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty

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