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Chapter 30: Ambiguity Aversion and Comparative Ignorance

Chapter 30: Ambiguity Aversion and Comparative Ignorance

pp. 528-542

Authors

, Duke University, , Stanford University
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Summary

ABSTRACT. Decisions under uncertainty depend not only on the degree of uncertainty but also on its source, as illustrated by Ellsberg's observation of ambiguity aversion. In this article we propose the comparative ignorance hypothesis, according to which ambiguity aversion is produced by a comparison with less ambiguous events or with more knowledgeable individuals. This hypothesis is supported in a series of studies showing that ambiguity aversion, present in a comparative context in which a person evaluates both clear and vague prospects, seems to disappear in a noncomparative context in which a person evaluates only one of these prospects in isolation.

INTRODUCTION

One of the fundamental problems of modern decision theory is the analysis of decisions under ignorance or ambiguity, where the probabilities of potential outcomes are neither specified in advance nor readily assessed on the basis of the available evidence. This issue was addressed by Knight [1921], who distinguished between measurable uncertainty or risk, which can be represented by precise probabilities, and unmeasurable uncertainty, which cannot. Furthermore, he suggested that entrepreneurs are compensated for bearing unmeasurable uncertainty as opposed to risk. Contemporaneously, Keynes [1921] distinguished between probability, representing the balance of evidence in favor of a particular proposition and the weight of evidence, representing the quantity of evidence supporting that balance. He then asked, “If two probabilities are equal in degree, ought we, in choosing our course of action, to prefer that one which is based on a greater body of knowledge?” [p. 313].

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