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Ambiguity Aversion in the Small and in the Large for Weighted Linear Utility

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  • Hazen, Gordon B
  • Lee, Jia-Sheng

Abstract

The widely observed preference for lotteries involving precise rather than vague or ambiguous probabilities is called ambiguity aversion. Ambiguity aversion cannot be predicted or explained by conventional expected utility models. For the subjectivity weighted linear utility (SWLU) model, we define both probability and payoff premiums for ambiguity, and introduce a local ambiguity aversion function a(u) that is proportional to these ambiguity premiums for small uncertainties. We show that one individual's ambiguity premiums are globally larger than another's if and only if his a(u) function is everywhere larger. Ambiguity aversion has been observed to increase (1) when the mean probability of gain increases and (2) when the mean probability of loss decreases. We show that such behavior is equivalent to a(u) increasing in both the gain and loss domains. Increasing ambiguity aversion also explains the observed excess of sellers' over buyers' prices for insurance against an ambiguous probability of loss. Copyright 1991 by Kluwer Academic Publishers

Suggested Citation

  • Hazen, Gordon B & Lee, Jia-Sheng, 1991. "Ambiguity Aversion in the Small and in the Large for Weighted Linear Utility," Journal of Risk and Uncertainty, Springer, vol. 4(2), pages 177-212, April.
    • Handle: RePEc:kap:jrisku:v:4:y:1991:i:2:p:177-212
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    Cited by:

    1. William Neilson, 2010. "A simplified axiomatic approach to ambiguity aversion," Journal of Risk and Uncertainty, Springer, vol. 41(2), pages 113-124, October.
    2. Cristina OTTAVIANI & Daniela VANDONE, 2011. "Decision-making under uncertainty and demand for insurance: an empirical study," Departmental Working Papers 2011-05, Department of Economics, Management and Quantitative Methods at Università degli Studi di Milano.

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