Testing axiomatizations of ambiguity aversion

Chen, Daniel L. and Schonger, Martin (2016) Testing axiomatizations of ambiguity aversion. IAST working paper, n. 16-61, Toulouse

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Official URL: http://iast.fr/pub/31142

Abstract

The study of the normative and positive theory of choice under uncertainty has made major advances through thought experiments often referred to as paradoxes: the St. Petersburg paradox, the Allais paradox, the Ellsberg paradox, and the Rabin paradox. Machina proposes a new thought experiment which posits a choice between two acts that have three outcomes. As in the Ellsberg paradox there are three events, but while the Ellsberg paradox has two (monetary) outcomes in Machina there are three. Machina shows that four prominent theories of ambiguity aversion predict indifference between the acts. Introspection, however, suggests that many people might very well strictly prefer one act over the other. This paper makes four contributions: first, to our knowledge, it is the first to experimentally implement the Machina thought experiment. Second, we employ a novel method to simultaneously elicit the certainty equivalent of an embedded lottery. Third, our results—across three experiments—indicate non-indifference, which rejects earlier theories of ambiguity aversion, but is consistent with a newer one, which we apply to explain our results. Fourth, we show that independence is a sufficient condition for indifference in the Machina paradox, and thereby explains why so many models predict indifference.

Item Type: Monograph (Working Paper)
Language: English
Date: October 2016
Place of Publication: Toulouse
Uncontrolled Keywords: Ellsberg paradox, Machina paradox, uncertainty aversion, independence axiom
JEL codes: D81 - Criteria for Decision-Making under Risk and Uncertainty
Subjects: B- ECONOMIE ET FINANCE
Divisions: TSE-R (Toulouse)
Institution: Université Toulouse Capitole
Site: UT1
Date Deposited: 15 Mar 2018 10:48
Last Modified: 30 May 2018 06:45
OAI ID: oai:tse-fr.eu:31142
URI: http://publications.ut-capitole.fr/id/eprint/23544

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