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Subjective Risk, Confidence, and Ambiguity

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  • Traeger, Christian P.

Abstract

The paper incorporates qualitative differences of probabilistic beliefs into a rational (or normatively motivated) decision framework. Probabilistic beliefs can range from objective probabilities to pure guesstimates. The decision maker in the present model takes into account his confidence in beliefs when evaluating general uncertain situations. From an axiomatic point of view, the approach stays as close as possible to the widespread von Neumann-Morgenstern framework. The resulting representation uses only basic tools from risk analysis, but employs them recursively. The paper extends the concept of smooth ambiguity aversion to a more general notion of aversion to the subjectivity of belief. As a special case, the framework permits a threefold disentanglement of intertemporal substitutability, Arrow-Pratt risk aversion, and smooth ambiguity aversion. A decision maker’s preferences can nest a variety of widespread decision criteria, which are selected according to his confidence in the uncertainty assessment of a particular setting.

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Bibliographic Info

Paper provided by Department of Agricultural & Resource Economics, UC Berkeley in its series Department of Agricultural & Resource Economics, UC Berkeley, Working Paper Series with number qt0gw7t7vn.

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Date of creation: 01 May 2011
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Handle: RePEc:cdl:agrebk:qt0gw7t7vn

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Keywords: ambiguity; confidence; subjective beliefs; expected utility; intertemporal substitutability; intertemporal risk aversion; recursive utility; uncertainty; climate change; behavior; Social and Behavioral Sciences;

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References

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  1. David Schmeidler, 1989. "Subjective Probability and Expected Utility without Additivity," Levine's Working Paper Archive 7662, David K. Levine.
  2. Miao, Jianjun & Hayashi, Takashi, 2011. "Intertemporal substitution and recursive smooth ambiguity preferences," Theoretical Economics, Econometric Society, vol. 6(3), September.
  3. Uzi Segal, 1989. "Two-Stage Lotteries Without the Reduction Axiom," UCLA Economics Working Papers 552, UCLA Department of Economics.
  4. Maccheroni, Fabio & Marinacci, Massimo & Rustichini, Aldo, 2006. "Dynamic variational preferences," Journal of Economic Theory, Elsevier, vol. 128(1), pages 4-44, May.
  5. Grant, Simon & Chateauneuf, A. & Eichberger, J., 2002. "Choice under Uncertainty with the Best and Worst in Mind: Neo-additive Capacities," Working Papers 2002-10, Rice University, Department of Economics.
  6. Peter Klibanoff & Massimo Marinacci & Sujoy Mukerji, 2002. "A smooth model of decision making under ambiguity," ICER Working Papers - Applied Mathematics Series, ICER - International Centre for Economic Research 11-2003, ICER - International Centre for Economic Research, revised Apr 2003.
  7. Klibanoff, Peter & Marinacci, Massimo & Mukerji, Sujoy, 2009. "Recursive smooth ambiguity preferences," Journal of Economic Theory, Elsevier, vol. 144(3), pages 930-976, May.
  8. Kyoungwon Seo, 2009. "Ambiguity and Second-Order Belief," Econometrica, Econometric Society, Econometric Society, vol. 77(5), pages 1575-1605, 09.
  9. Gilboa, Itzhak & Schmeidler, David, 1989. "Maxmin expected utility with non-unique prior," Journal of Mathematical Economics, Elsevier, vol. 18(2), pages 141-153, April.
  10. Ergin, Haluk & Gul, Faruk, 2009. "A theory of subjective compound lotteries," Journal of Economic Theory, Elsevier, vol. 144(3), pages 899-929, May.
  11. David M Kreps & Evan L Porteus, 1978. "Temporal Resolution of Uncertainty and Dynamic Choice Theory," Levine's Working Paper Archive 625018000000000009, David K. Levine.
  12. Weil, Philippe, 1990. "Nonexpected Utility in Macroeconomics," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 105(1), pages 29-42, February.
  13. Ghirardato, Paolo & Maccheroni, Fabio & Marinacci, Massimo, 2004. "Differentiating ambiguity and ambiguity attitude," Journal of Economic Theory, Elsevier, vol. 118(2), pages 133-173, October.
  14. Grandmont, Jean-Michel, 1972. "Continuity properties of a von Neumann-Morgenstern utility," Journal of Economic Theory, Elsevier, vol. 4(1), pages 45-57, February.
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Citations

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Cited by:
  1. Lemoine, Derek M. & Traeger, Christian P., 2011. "Tipping points and ambiguity in the economics of climate change," Department of Agricultural & Resource Economics, UC Berkeley, Working Paper Series, Department of Agricultural & Resource Economics, UC Berkeley qt9nd591ww, Department of Agricultural & Resource Economics, UC Berkeley.
  2. Traeger, Christian P., 2011. "Discounting and confidence," Department of Agricultural & Resource Economics, UC Berkeley, Working Paper Series, Department of Agricultural & Resource Economics, UC Berkeley qt61m836d1, Department of Agricultural & Resource Economics, UC Berkeley.
  3. Douglas Norton & R. Isaac, 2012. "Experts with a conflict of interest: a source of ambiguity?," Experimental Economics, Springer, vol. 15(2), pages 260-277, June.
  4. Traeger, Christian P., 2011. "Interemporal Risk Aversion - or - Wouldn't it be Nice to Tell Whether Robinson Crusoe is Risk," Department of Agricultural & Resource Economics, UC Berkeley, Working Paper Series, Department of Agricultural & Resource Economics, UC Berkeley qt67d581xt, Department of Agricultural & Resource Economics, UC Berkeley.
  5. Christopher Anderson, 2012. "Ambiguity aversion in multi-armed bandit problems," Theory and Decision, Springer, vol. 72(1), pages 15-33, January.

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