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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
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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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Related research

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

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References

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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.
  3. Larry G. Epstein & Jiankang Zhang, 1999. "Subjective Probabilities on Subjectively Unambiguous Events," Carleton Economic Papers 99-18, Carleton University, Department of Economics.
  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.
  5. Haluk Ergin & Faruk Gul, 2003. "A Subjective Theory of Compound Lotteries," Levine's Bibliography 506439000000000406, UCLA Department of Economics.
  6. Ross, Stephen A., 1999. "Adding Risks: Samuelson's Fallacy of Large Numbers Revisited," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 34(03), pages 323-339, September.
  7. Uzi Segal, 2000. "Two Stage Lotteries Without the Reduction Axiom," Levine's Working Paper Archive 7599, David K. Levine.
  8. Itzhak Gilboa & David Schmeidler, 1992. "Case-Based Decision Theory," Discussion Papers 994, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  9. 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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  14. Ramon Casadesus-Masanell & Peter Klibanoff & Emre Ozdenoren, 1998. "Maximum Expected Utility over Savage Acts with a Set of Priors," Discussion Papers 1218, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  15. 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.
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  24. Larry Epstein, 1997. "Uncertainty Aversion," Working Papers epstein-97-01, University of Toronto, 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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