Reference dependent ambiguity aversion: theory and experiment
AbstractIn standard models of ambiguity, the evaluation of an ambiguous asset, as of a risky asset, is considered as an independent process. In this process only information directly pertaining to the ambiguous asset is used. These models face significant challenges from the finding that ambiguity aversion is more pronounced when an ambiguous asset is evaluated alongside a risky asset than in isolation. To explain this phenomenon, we developed a theoretical model based on reference dependence in probabilities. According to this model, individuals (1) form subjective beliefs on the potential winning probability of the ambiguous asset; (2) use the winning probability of the (simultaneously presented) risky asset as a reference point to evaluate the potential winning probabilities of the ambiguous asset; (3) code potential winning probabilities of the ambiguous asset that are greater than the reference point as gains and those that are smaller than the reference point as losses; (4) weight losses in probability heavier than gains in probability. We tested the crucial assumption, reference dependence in probabilities, in an experiment and found supporting evidence.
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Bibliographic InfoPaper provided by University Library of Munich, Germany in its series MPRA Paper with number 35289.
Date of creation: 01 Nov 2011
Date of revision: 08 Dec 2011
Ambiguity Aversion; Reference Point; Comparison; Experiment;
Find related papers by JEL classification:
- G1 - Financial Economics - - General Financial Markets
- C9 - Mathematical and Quantitative Methods - - Design of Experiments
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