- A Bayesian Approach To Uncertainty Aversion
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.
|Date of creation:||Sep 1999|
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