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A Bayesian Approach to Uncertainty Aversion

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  • Vincent Feltkamp

    (Statistics Netherlands)

  • Yoram Halevy

    (University of British Columbia)

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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Bibliographic Info

Paper provided by Econometric Society in its series Econometric Society World Congress 2000 Contributed Papers with number 1125.

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Date of creation: 01 Aug 2000
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Handle: RePEc:ecm:wc2000:1125

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  1. Sarin, Rakesh & Wakker, Peter, 1997. "A Single-Stage Approach to Anscombe and Aumann's Expected Utility," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 64(3), pages 399-409, July.
  2. David Schmeidler, 1989. "Subjective Probability and Expected Utility without Additivity," Levine's Working Paper Archive 7662, David K. Levine.
  3. Aumann, Robert J., 1997. "Rationality and Bounded Rationality," Games and Economic Behavior, Elsevier, Elsevier, vol. 21(1-2), pages 2-14, October.
  4. Larry Epstein, 1997. "Uncertainty Aversion," Working Papers epstein-97-01, University of Toronto, Department of Economics.
  5. Sarin, Rakesh K & Wakker, Peter, 1992. "A Simple Axiomatization of Nonadditive Expected Utility," Econometrica, Econometric Society, Econometric Society, vol. 60(6), pages 1255-72, November.
  6. Gilboa, Itzhak, 1987. "Expected utility with purely subjective non-additive probabilities," Journal of Mathematical Economics, Elsevier, vol. 16(1), pages 65-88, February.
  7. Segal, Uzi, 1987. "The Ellsberg Paradox and Risk Aversion: An Anticipated Utility Approach," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 28(1), pages 175-202, February.
  8. Machina, Mark J & Schmeidler, David, 1992. "A More Robust Definition of Subjective Probability," Econometrica, Econometric Society, Econometric Society, vol. 60(4), pages 745-80, July.
  9. Hoffman, Elizabeth & McCabe, Kevin & Smith, Vernon L, 1996. "Social Distance and Other-Regarding Behavior in Dictator Games," American Economic Review, American Economic Association, American Economic Association, vol. 86(3), pages 653-60, June.
  10. Yaari, Menahem E, 1987. "The Dual Theory of Choice under Risk," Econometrica, Econometric Society, Econometric Society, vol. 55(1), pages 95-115, January.
  11. Gilboa, Itzhak & Schmeidler, David, 1989. "Maxmin expected utility with non-unique prior," Journal of Mathematical Economics, Elsevier, vol. 18(2), pages 141-153, April.
  12. Rothschild, Michael & Stiglitz, Joseph E., 1970. "Increasing risk: I. A definition," Journal of Economic Theory, Elsevier, Elsevier, vol. 2(3), pages 225-243, September.
  13. Camerer, Colin & Weber, Martin, 1992. " Recent Developments in Modeling Preferences: Uncertainty and Ambiguity," Journal of Risk and Uncertainty, Springer, Springer, vol. 5(4), pages 325-70, October.
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Cited by:
  1. repec:clg:wpaper:2013-27 is not listed on IDEAS
  2. Pierre Fleckinger, 2007. "On Multiagent Moral Hazard under Technological Uncertainty," Working Papers hal-00240716, HAL.
  3. Christoph Kuzmics, 2012. "Inferring preferences from choices under uncertainty," Working Papers 462, Bielefeld University, Center for Mathematical Economics.
  4. Al-Najjar, Nabil I. & Weinstein, Jonathan, 2013. "A Bayesian Model of Knightian Uncertainty," Economics Series, Institute for Advanced Studies 300, Institute for Advanced Studies.
  5. Mark Dean & Pietro Ortoleva, 2012. "Allais, Ellsberg, and Preferences for Hedging," Working Papers 2012-2, Brown University, Department of Economics.
  6. Alfred Müller & Marco Scarsini, 2002. "Even Risk-Averters may Love Risk," Theory and Decision, Springer, Springer, vol. 52(1), pages 81-99, February.
  7. Zvi Safra & Uzi Segal, 2005. "Are Universal Preferences Possible? Calibration Results for Non-Expected Utility Theories," Boston College Working Papers in Economics, Boston College Department of Economics 633, Boston College Department of Economics.
  8. Eric Rasmusen, 2008. "Career Concerns and Ambiguity Aversion," Working Papers, Indiana University, Kelley School of Business, Department of Business Economics and Public Policy 2008-12, Indiana University, Kelley School of Business, Department of Business Economics and Public Policy.
  9. Rick Harbaugh, 2005. "Prospect Theory or Skill Signaling?," Working Papers, Indiana University, Kelley School of Business, Department of Business Economics and Public Policy 2005-06, Indiana University, Kelley School of Business, Department of Business Economics and Public Policy.
  10. Yang, Chun-Lei & Yao, Lan, 2011. "Ellsberg Paradox and Second-order Preference Theories on Ambiguity: Some New Experimental Evidence," MPRA Paper 28531, University Library of Munich, Germany.
  11. Takashi Kamihigashi & John Stachurski, 2014. "Partial Stochastic Dominance," Working Papers, Department of Research, Ipag Business School 2014-403, Department of Research, Ipag Business School.
  12. Gregory DeAngelo & Gary Charness, 2012. "Deterrence, expected cost, uncertainty and voting: Experimental evidence," Journal of Risk and Uncertainty, Springer, Springer, vol. 44(1), pages 73-100, February.

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