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- A Bayesian Approach To Uncertainty Aversion

  • Vincent Feltkamp

    (Statistics Netherlands)

  • Yoram Halevy

    (University of Pennsylvania)

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.

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File URL: http://www.ivie.es/downloads/docs/wpasad/wpasad-1999-14.pdf
File Function: Fisrt version / Primera version, 1999
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Paper provided by Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie) in its series Working Papers. Serie AD with number 1999-14.

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Length: 23 pages
Date of creation: Sep 1999
Date of revision:
Publication status: Published by Ivie
Handle: RePEc:ivi:wpasad:1999-14
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  1. Mark J. Machina & David Schmeidler, 1990. "A More Robust Definition of Subjective Probability," Discussion Paper Serie A 306, University of Bonn, Germany.
  2. Camerer, Colin & Weber, Martin, 1992. " Recent Developments in Modeling Preferences: Uncertainty and Ambiguity," Journal of Risk and Uncertainty, Springer, vol. 5(4), pages 325-70, October.
  3. Sarin, Rakesh K & Wakker, Peter, 1992. "A Simple Axiomatization of Nonadditive Expected Utility," Econometrica, Econometric Society, vol. 60(6), pages 1255-72, November.
  4. Larry Epstein, 1997. "Uncertainty Aversion," Working Papers epstein-97-01, University of Toronto, Department of Economics.
  5. Uzi Segal, 1985. "The Ellsberg Paradox and Risk Aversion: An Anticipated Utility Approach," UCLA Economics Working Papers 362, UCLA Department of Economics.
  6. Hoffman, Elizabeth & McCabe, Kevin & Smith, Vernon L, 1996. "Social Distance and Other-Regarding Behavior in Dictator Games," American Economic Review, American Economic Association, vol. 86(3), pages 653-60, June.
  7. Gilboa, Itzhak & Schmeidler, David, 1989. "Maxmin expected utility with non-unique prior," Journal of Mathematical Economics, Elsevier, vol. 18(2), pages 141-153, April.
  8. Sarin, Rakesh & Wakker, Peter, 1997. "A Single-Stage Approach to Anscombe and Aumann's Expected Utility," Review of Economic Studies, Wiley Blackwell, vol. 64(3), pages 399-409, July.
  9. Gilboa, Itzhak, 1987. "Expected utility with purely subjective non-additive probabilities," Journal of Mathematical Economics, Elsevier, vol. 16(1), pages 65-88, February.
  10. Rothschild, Michael & Stiglitz, Joseph E., 1970. "Increasing risk: I. A definition," Journal of Economic Theory, Elsevier, vol. 2(3), pages 225-243, September.
  11. Aumann, Robert J., 1997. "Rationality and Bounded Rationality," Games and Economic Behavior, Elsevier, vol. 21(1-2), pages 2-14, October.
  12. David Schmeidler, 1989. "Subjective Probability and Expected Utility without Additivity," Levine's Working Paper Archive 7662, David K. Levine.
  13. Yaari, Menahem E, 1987. "The Dual Theory of Choice under Risk," Econometrica, Econometric Society, vol. 55(1), pages 95-115, January.
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