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The Ellsberg Paradox and Risk Aversion: An Anticipated Utility Approach

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  • Uzi Segal

    (University of Toronto)

Abstract

The paper describes a decision process under which it is rational to prefer a lottery with known probabilities to a similar ambiguous lottery where the decision maker does not know the exact values of the probabilities (the "Ellsberg paradox"). This is done by modeling ambiguous lotteries as two-stage lotteries, by assuming the independence axiom without the reduction of compound lotteries axiom, and by using the anticipated utility functional. This paper also gives conditions under which less ambiguity is preferred and presents some comparative statics analysis as well as some inter-personal comparisons. Finally, it proves that within the anticipated utility framework, risk and ambiguity are almost identical. Copyright 1987 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.
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Suggested Citation

  • Uzi Segal, 1985. "The Ellsberg Paradox and Risk Aversion: An Anticipated Utility Approach," UCLA Economics Working Papers 362, UCLA Department of Economics.
    • Handle: RePEc:cla:uclawp:362
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    References listed on IDEAS

    as
    1. Quiggin, John, 1982. "A theory of anticipated utility," Journal of Economic Behavior & Organization, Elsevier, vol. 3(4), pages 323-343, December.
    2. K. R. W. Brewer, 1963. "Decisions Under Uncertainty: Comment," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 77(1), pages 159-161.
    3. Uzi Segal, 1984. "Nonlinear Decision Weights with the Independence Axiom," UCLA Economics Working Papers 353, UCLA Department of Economics.
    4. Roger Sherman, 1974. "The Psychological Difference Between Ambiguity and Risk," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 88(1), pages 166-169.
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    7. Daniel Kahneman & Amos Tversky, 2013. "Prospect Theory: An Analysis of Decision Under Risk," World Scientific Book Chapters, in: Leonard C MacLean & William T Ziemba (ed.), HANDBOOK OF THE FUNDAMENTALS OF FINANCIAL DECISION MAKING Part I, chapter 6, pages 99-127, World Scientific Publishing Co. Pte. Ltd..
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