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Decision Making and Trade without Probabilities

Author

Listed:
  • Jack Stecher
  • Radhika Lunawat
  • Kira Pronin
  • John Dickhaut

Abstract

What is a rational decision-maker supposed to do when facing an unfamiliar problem, where there is uncertainty but no basis for making probabilistic assessments? One answer is to use a form of expected utility theory, and assume that agents assign their own subjective probabilities to each element of the (presumably known) state space. In contrast, this paper presents a model in which agents do not form subjective probabilities over the elements of the state space, but nonetheless use new information to update their beliefs about what the elements of the state space are. This model is shown to lead to different predictions about trading behavior in a simple asset market under uncertainty. A controlled laboratory experiment tests the predictions of this model against those of expected utility theory and against the hypothesis that subjects act na¨ıvely and non-strategically. The results suggest that a lack of subjective probabilities does not imply irrational or unpredictable behavior, but instead allows individuals to use both what they know and knowledge of what they do not know in their decision making. Comment un décideur rationnel est-il censé réagir face à un problème qui ne lui est pas familier lorsqu'il existe une certaine incertitude, et en l'absence d'une base sur laquelle effectuer des estimations probabilistes? Une solution consiste à utiliser une forme de la théorie de l'utilité espérée et de présumer que les agents attribuent leurs propres probabilités subjectives à chaque élément de la représentation d'état (sans doute connue). Par contraste, notre article présente un modèle où les agents ne forment pas de probabilités subjectives sur les éléments de la représentation d'état, mais utilisent de nouveaux renseignements afin de mettre à jour leurs croyances sur les éléments formant la représentation d'état. Le comportement des échanges avec ce modèle dans un marché d'actifs simple et incertain nous mène à des prédictions différentes. En utilisant une expérience contrôlée en laboratoire, nous avons vérifié les prédictions de ce modèle contre celles de la théorie de l'utilité espérée et contre l'hypothèse que les sujets agissent avec naïveté et sans recourir à une stratégie. Les résultats suggèrent qu'un manque de probabilités subjectives n'implique pas un comportement irrationnel ou imprévisible, mais permet plutôt aux individus d'utiliser autant l'information qu'ils possèdent que la connaissance de l'information qu'ils ne possèdent pas dans leur prise de décision.

Suggested Citation

  • Jack Stecher & Radhika Lunawat & Kira Pronin & John Dickhaut, 2007. "Decision Making and Trade without Probabilities," CIRANO Working Papers 2007s-21, CIRANO.
  • Handle: RePEc:cir:cirwor:2007s-21
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    File URL: http://www.cirano.qc.ca/files/publications/2007s-21.pdf
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    References listed on IDEAS

    as
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    Citations

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    Cited by:

    1. Todd R. Kaplan & Shmuel Zamir, 2014. "Advances in Auctions," Discussion Papers 1405, University of Exeter, Department of Economics.
    2. Adam Dominiak & Jean-Philippe Lefort, 2013. "Agreement theorem for neo-additive beliefs," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 52(1), pages 1-13, January.
    3. Kaplan, Todd R. & Zamir, Shmuel, 2015. "Advances in Auctions," Handbook of Game Theory with Economic Applications, Elsevier.
    4. Michele Lombardi & Naoki Yoshihara, 2013. "A full characterization of nash implementation with strategy space reduction," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 54(1), pages 131-151, September.
    5. Brishti Guha, 2012. "Gambling on Genes: Ambiguity Aversion Explains Investment in Sisters’ Children," Working Papers 33-2012, Singapore Management University, School of Economics.
    6. Robert Nau, 2011. "Risk, ambiguity, and state-preference theory," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 48(2), pages 437-467, October.
    7. Luciano Castro & Alain Chateauneuf, 2011. "Ambiguity aversion and trade," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 48(2), pages 243-273, October.
    8. repec:eee:wdevel:v:100:y:2017:i:c:p:69-84 is not listed on IDEAS
    9. Fujii, Tomoki, 2017. "Dynamic Poverty Decomposition Analysis: An Application to the Philippines," World Development, Elsevier, vol. 100(C), pages 69-84.
    10. Alain Chateauneuf & Luciano De Castro, 2011. "Ambiguity Aversion and Absence of Trade," Discussion Papers 1535, Northwestern University, Center for Mathematical Studies in Economics and Management Science.

    More about this item

    Keywords

    Uncertainty; non-expected utility; incomplete preferences; ambiguity.; Incertitude; utilité non espérée; préférences incomplètes; ambiguïté.;

    JEL classification:

    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting
    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness

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