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Ellsberg`s 2-Color Experiment, Bid-Ask Behavior and Ambiguity

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  • Sujoy Mukerji
  • Jean-Marc Tallon

Abstract

Results in this note relate the observation of an interval of prices at which a DM strictly prefers to hold a zero position on an asset (termed `bid-ask behavior`) to the DM`s perception of the underlying payoff relevant events as ambiguous, as the term is defined in Epstein and Zhang (2001). The connection between bid-ask behavior and ambiguity is established without invoking a parametric preference form, such as the Choquet expected utility or the max-min multiple priors model. This allows us to draw an observable distinction between bid-ask behavior that may arise purely due to first-order risk aversion type effects, such as those which could arise even if preferences were probabilistically sophisticated, and the bid-ask behavior that involve ambiguity perceptions.

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Bibliographic Info

Paper provided by University of Oxford, Department of Economics in its series Economics Series Working Papers with number 114.

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Date of creation: 01 Jul 2002
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Handle: RePEc:oxf:wpaper:114

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Related research

Keywords: Ellsberg Paradox; bid-ask spread; testing for ambiguity aversion; uncertainty aversion; unforeseen cointingencies; subjective state spaces.;

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References

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  1. Machina, Mark J, 2001. " Payoff Kinks in Preferences over Lotteries," Journal of Risk and Uncertainty, Springer, Springer, vol. 23(3), pages 207-60, November.
  2. Epstein, Larry G & Wang, Tan, 1994. "Intertemporal Asset Pricing Under Knightian Uncertainty," Econometrica, Econometric Society, Econometric Society, vol. 62(2), pages 283-322, March.
  3. Hong Chew Soo & Epstein Larry G. & Wakker Peter, 1993. "A Unifying Approach to Axiomatic Non-expected Utility Theories: Correction and Comment," Journal of Economic Theory, Elsevier, Elsevier, vol. 59(1), pages 183-188, February.
  4. Mukerji, S., 1997. "Ambiguity aversion and incompleteness of contractual form," Discussion Paper Series In Economics And Econometrics 9715, Economics Division, School of Social Sciences, University of Southampton.
  5. Larry G. Epstein & Jiankang Zhang, 1999. "Subjective Probabilities on Subjectively Unambiguous Events," Carleton Economic Papers 99-18, Carleton University, Department of Economics.
  6. Dow, James & Werlang, Sergio Ribeiro da Costa, 1992. "Uncertainty Aversion, Risk Aversion, and the Optimal Choice of Portfolio," Econometrica, Econometric Society, Econometric Society, vol. 60(1), pages 197-204, January.
  7. Gul, Faruk, 1991. "A Theory of Disappointment Aversion," Econometrica, Econometric Society, Econometric Society, vol. 59(3), pages 667-86, May.
  8. Eddie Dekel, 1997. "A Unique Subjective State Space for Unforeseen Contingencies," Discussion Papers, Northwestern University, Center for Mathematical Studies in Economics and Management Science 1202, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  9. Epstein, Larry G., 2000. "Are Probabilities Used in Markets ?," Journal of Economic Theory, Elsevier, Elsevier, vol. 91(1), pages 86-90, March.
  10. Epstein, L.G. & Zhang, J., 1998. "Subjective Probabilities on Subjectivity Unambiguous Event," RCER Working Papers 456, University of Rochester - Center for Economic Research (RCER).
  11. Machina, Mark J, 2000. "Payoff Kinks in Preferences Over Lotteries," University of California at San Diego, Economics Working Paper Series, Department of Economics, UC San Diego qt7vn7d2hs, Department of Economics, UC San Diego.
  12. Ghirardato, Paolo & Marinacci, Massimo, 2002. "Ambiguity Made Precise: A Comparative Foundation," Journal of Economic Theory, Elsevier, Elsevier, vol. 102(2), pages 251-289, February.
  13. Epstein Larry G. & Wang Tan, 1995. "Uncertainty, Risk-Neutral Measures and Security Price Booms and Crashes," Journal of Economic Theory, Elsevier, Elsevier, vol. 67(1), pages 40-82, October.
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Cited by:
  1. Larry Epstein & Martin Schneider, 2002. "Learning Under Ambiguity," RCER Working Papers 497, University of Rochester - Center for Economic Research (RCER), revised Mar 2005.

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