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- A Bayesian Approach To Uncertainty Aversion

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Author Info

  • Vincent Feltkamp

    (Statistics Netherlands)

  • Yoram Halevy

    (University of Pennsylvania)

Abstract

The Ellsberg paradox demonstrates that peoples belief over uncertainevents might not be representable by subjective probability. We relate this paradox to other commonly observed anomalies, suchas a rejection of the backward induction prediction in the one-shot Ultimatum Game. We argue that the pattern common to theseobservations is that the behavior is governed by rational rules. These rules have evolved and are optimal within the repeated andconcurrent environments that people usually encounter. When an individual relies on these rules to analyzeone-shot or single circumstances, paradoxes emerge. We show that when a risk averse individualhas a Bayesian prior and uses a rule which is optimal for simultaneous and positively correlatedambiguous risks to evaluate a single vague circumstance, his behavior will exhibit uncertaintyaversion. Thus, the behavior predicted by Ellsberg may be explained within the Bayesian expectedutility paradigm.

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File URL: http://www.ivie.es/downloads/docs/wpasad/wpasad-1999-14.pdf
File Function: Fisrt version / Primera version, 1999
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Bibliographic Info

Paper provided by Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie) in its series Working Papers. Serie AD with number 1999-14.

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Length: 23 pages
Date of creation: Sep 1999
Date of revision:
Publication status: Published by Ivie
Handle: RePEc:ivi:wpasad:1999-14

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Keywords: Ellsberg paradox; rule rationality; ambiguity aversion; risk aversion;

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References

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  1. Gilboa, Itzhak & Schmeidler, David, 1989. "Maxmin expected utility with non-unique prior," Journal of Mathematical Economics, Elsevier, vol. 18(2), pages 141-153, April.
  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.
  3. Yaari, Menahem E, 1987. "The Dual Theory of Choice under Risk," Econometrica, Econometric Society, vol. 55(1), pages 95-115, January.
  4. Rothschild, Michael & Stiglitz, Joseph E., 1970. "Increasing risk: I. A definition," Journal of Economic Theory, Elsevier, vol. 2(3), pages 225-243, September.
  5. Machina,Mark & Schmeidler,David, 1991. "A more robust definition of subjective probability," Discussion Paper Serie A 365, University of Bonn, Germany.
  6. 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, vol. 28(1), pages 175-202, February.
  7. Schmeidler, David, 1989. "Subjective Probability and Expected Utility without Additivity," Econometrica, Econometric Society, vol. 57(3), pages 571-87, May.
  8. Hoffman, Elizabeth & McCabe, Kevin & Smith, Vernon L, 1996. "Social Distance and Other-Regarding Behavior in Dictator Games," American Economic Review, American Economic Association, vol. 86(3), pages 653-60, June.
  9. Sarin, Rakesh K & Wakker, Peter, 1992. "A Simple Axiomatization of Nonadditive Expected Utility," Econometrica, Econometric Society, vol. 60(6), pages 1255-72, November.
  10. Aumann, Robert J., 1997. "Rationality and Bounded Rationality," Games and Economic Behavior, Elsevier, vol. 21(1-2), pages 2-14, October.
  11. Gilboa, Itzhak, 1987. "Expected utility with purely subjective non-additive probabilities," Journal of Mathematical Economics, Elsevier, vol. 16(1), pages 65-88, February.
  12. Larry Epstein, 1997. "Uncertainty Aversion," Working Papers epstein-97-01, University of Toronto, Department of Economics.
  13. Camerer, Colin & Weber, Martin, 1992. " Recent Developments in Modeling Preferences: Uncertainty and Ambiguity," Journal of Risk and Uncertainty, Springer, vol. 5(4), pages 325-70, October.
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Citations

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Cited by:
  1. David Cooper & David Johnson, 2013. "Ambiguity in Performance Pay: An Online Experiment," Working Papers 2013-27, Department of Economics, University of Calgary, revised 14 Nov 2013.
  2. Gregory DeAngelo & Gary Charness, 2012. "Deterrence, expected cost, uncertainty and voting: Experimental evidence," Journal of Risk and Uncertainty, Springer, vol. 44(1), pages 73-100, February.
  3. Christoph Kuzmics, 2012. "Inferring preferences from choices under uncertainty," Working Papers 462, Bielefeld University, Center for Mathematical Economics.
  4. Zvi Safra & Uzi Segal, 2005. "Are Universal Preferences Possible? Calibration Results for Non-Expected Utility Theories," Boston College Working Papers in Economics 633, Boston College Department of Economics.
  5. Al-Najjar, Nabil I. & Weinstein, Jonathan, 2013. "A Bayesian Model of Knightian Uncertainty," Economics Series 300, Institute for Advanced Studies.
  6. Mark Dean & Pietro Ortoleva, 2012. "Allais, Ellsberg, and Preferences for Hedging," Working Papers 2012-2, Brown University, Department of Economics.
  7. Rasmusen, Eric, 2010. "Career concerns and ambiguity aversion," Economics Letters, Elsevier, vol. 108(2), pages 175-177, August.
  8. Alfred Müller & Marco Scarsini, 2002. "Even Risk-Averters may Love Risk," Theory and Decision, Springer, vol. 52(1), pages 81-99, February.
  9. Pierre Fleckinger, 2007. "On Multiagent Moral Hazard under Technological Uncertainty," Working Papers hal-00240716, HAL.
  10. 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.
  11. 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.

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