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A Bayesian Approach to Uncentainty Aversion

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  • Yoram Halevy
  • Vincent Feltkamp

Abstract

The Ellsberg paradox demonstrates that people's belief over uncertain events might not be representable by subjective probability. We argue that Uncertainty Aversion may be viewed as a case of "Rule Rationality''. This paradigm claims that people's decision making has evolved to simple rules that perform well in most regular environments. Such an environment consists of replicas of some basic singular circumstance. When the rule is applied to a singular environment, the behavior may seem paradoxical. We claim that the regular environment in which decisions under uncertainty take place, is described by one decision that spans multiple ambiguous risks, which are positively correlated. We show that when a risk averse individual has a Bayesian prior and uses a rule, which is optimal for the regular ambiguous environment, to evaluate a singular vague circumstance - his behavior will exhibit uncertainty aversion. Thus, the behavior predicted by Ellsberg may be explained within the Bayesian expected utility paradigm.

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Paper provided by Penn Economics Department in its series Penn CARESS Working Papers with number f17f3e2c6ad93e4b53fd58fc9b88a886.

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Handle: RePEc:cla:penntw:f17f3e2c6ad93e4b53fd58fc9b88a886

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  1. Alfred Müller & Marco Scarsini, 2002. "Even Risk-Averters may Love Risk," Theory and Decision, Springer, vol. 52(1), pages 81-99, February.
  2. Sarin, R. & Wakker, P.P., 1996. "A Single-Stage Approach to Anscombe and Aumann's Expected Utility," Discussion Paper 1996-45, Tilburg University, Center for Economic Research.
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  4. Sujoy Mukerji & Peter Klibanoff, 2002. "A Smooth Model of Decision,Making Under Ambiguity," Economics Series Working Papers 113, University of Oxford, Department of Economics.
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Citations

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Cited by:
  1. Yoram Halevy, 2007. "Ellsberg Revisited: An Experimental Study," Econometrica, Econometric Society, vol. 75(2), pages 503-536, 03.
  2. Mark Dean & Pietro Ortoleva, 2012. "Allais, Ellsberg, and Preferences for Hedging," Working Papers 2012-2, Brown University, Department of Economics.
  3. Alfred Müller & Marco Scarsini, 2002. "Even Risk-Averters may Love Risk," Theory and Decision, Springer, vol. 52(1), pages 81-99, February.
  4. Rick Harbaugh, 2005. "Prospect Theory or Skill Signaling?," Working Papers 2005-06, Indiana University, Kelley School of Business, Department of Business Economics and Public Policy.
  5. Christoph Kuzmics, 2012. "Inferring preferences from choices under uncertainty," Working Papers 462, Bielefeld University, Center for Mathematical Economics.

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