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A subjective theory of compound lotteries

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  • Haluk Ergin
  • Faruk Gul

Abstract

We develop a Savage-type model of choice under uncertainty in which agents identify uncertain prospects with subjective compound lotteries. Our theory permits issue preference; that is, agents may not be indifferent among gambles that yield the same probability distribution if they depend on different issues. Hence, we establish subjective foundations for the Anscombe-Aumann framework and other models with two different types of probabilities. We define second-order risk as risk that resolves in the first stage of the compound lottery and show the equivalence of aversion to this risk with issue preference, the Ellsberg paradox, and uncertainty aversion

Suggested Citation

  • Haluk Ergin & Faruk Gul, 2004. "A subjective theory of compound lotteries," Econometric Society 2004 North American Summer Meetings 152, Econometric Society.
    • Handle: RePEc:ecm:nasm04:152
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    3. Cerreia-Vioglio, S. & Maccheroni, F. & Marinacci, M. & Montrucchio, L., 2011. "Uncertainty averse preferences," Journal of Economic Theory, Elsevier, vol. 146(4), pages 1275-1330, July.
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    5. Chew, Soo Hong & Sagi, Jacob S., 2008. "Small worlds: Modeling attitudes toward sources of uncertainty," Journal of Economic Theory, Elsevier, vol. 139(1), pages 1-24, March.
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    10. Gino Cateau, 2005. "Monetary Policy under Model and Data-Parameter Uncertainty," Staff Working Papers 05-6, Bank of Canada.
    11. Cateau, Gino, 2007. "Monetary policy under model and data-parameter uncertainty," Journal of Monetary Economics, Elsevier, vol. 54(7), pages 2083-2101, October.
    12. Philipp Karl ILLEDITSCH, 2009. "Ambiguous Information, Risk Aversion, and Asset Pricing," 2009 Meeting Papers 802, Society for Economic Dynamics.
    13. Hansen, Lars Peter & Sargent, Thomas J., 2007. "Recursive robust estimation and control without commitment," Journal of Economic Theory, Elsevier, vol. 136(1), pages 1-27, September.
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    More about this item

    Keywords

    issue preference; uncertainty aversion; Ellsberg paradox; Savage; compound lotteries;
    All these keywords.

    JEL classification:

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

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