Ambiguity Preferences Research Articles

Continuous-time smooth ambiguity preferences

This study extends the smooth ambiguity preferences model proposed by Klibanoff et al. (2005) to a continuous-time dynamic setting. It is known that the original smooth ambiguity preferences converge to the subjective expected utility as the time interval shortens so that decision makers do not exhibit any ambiguity-sensitive behavior in the continuous-time limit. Accordingly, this study proposes an alternative model of these preferences that interchanges the role of the second-order utility function with that of the second-order probability to prevent the smooth ambiguity attitude of decision maker from evaporating in the continuous-time limit. By utilizing the utility convergence results established by Kraft and Seifried (2014), our model is eventually represented by the stochastic differential utility with distorted beliefs so that most existing techniques in economics and financial studies can be made applicable together with these distorted beliefs. We give an asset-pricing example to demonstrate the applicability of our model.

Ambiguity preferences, risk taking and the banking firm

This paper examines the risk taking behavior of a banking firm facing ambiguity and possessing smooth ambiguity preferences. Ambiguity is modeled by a second-order probability distribution that captures the bank’s uncertainty about which of the subjective beliefs govern the return on its loans. Ambiguity aversion is modeled by a concave transformation of the (first-order) expected utility of profit conditional on each plausible subjective distribution of the random loan return. Within this framework, we show that the bank finds it less attractive to take risk in the presence than in the absence of ambiguity. This result extends to the case of greater ambiguity aversion. Given that the bank’s smooth ambiguity preferences exhibit non-increasing absolute ambiguity aversion, imposing a more stringent capital requirement to the bank has the desired effect that limits the bank’s incentive to take on excessive risk.

Risk, Ambiguity and Prudence During Adolescence

Given adolescents’ propensity to engage in risky activities, experimentally elicited risk has received much attention in adolescence. Very few studies have looked at other dimensions of decision-making under uncertainty in this special population. In this study, we attempted to close this gap by conducting a “lab in the field” experiment with adolescents. Our goals were twofold. Firstly, this study provides an initial investigation of the higher order concept of prudence during adolescence and its relationship with risk and ambiguity. Secondly, we examined the influence of demographic characteristics of the decision-maker on preferences for risk, ambiguity and prudence. Specifically, we focused on gender, age, cognitive and non-cognitive abilities as potential demographic moderators. Our results showed that adolescents are ambiguity averse and display prudent behavior, despite being risk neutral on average. Secondly, we found that various demographic factors influenced adolescents’ attitudes towards risk, ambiguity and prudence. These demographic characterizations aid in targeting policy to specific groups of adolescents and we suggested several possibilities for application throughout the discussion.

The Impact of Overconfidence and Ambiguity Attitude on Market Entry

We study the behavioral drivers of market entry. An experiment allows us to disentangle the impact on entry across different types of markets of two key behavioral mechanisms: overconfidence and attitude toward ambiguity. We theorize and show that the causal effect of overconfidence on entry is limited to skill-based markets and does not appear in those that are chance based. Moreover, we also find that, independent of confidence levels, individuals exhibit ambiguity-seeking behavior when the result of the competition depends on their skills, which in turn leads to higher levels of entry. This preference for ambiguity can thus explain results that have previously been attributed to overconfidence. Our results challenge existing literature that has inferred overconfidence from differential entry levels across types of markets.

An Equilibrium Asset Pricing Model under the Dual Theory of the Smooth Ambiguity Model

This paper considers an equilibrium asset pricing model in a static pure exchange economy under ambiguity. Ambiguity preference is represented by the dual theory of the smooth ambiguity model [6]. We show the existence and the uniqueness of the equilibrium in the economy and derive the state price density (SPD). The equilibrium excess return, which can be seen as an extension of the capital asset pricing model (CAPM) under risk to ambiguity, is derived from the SPD. We also determine the effects of ambiguity preference on the excess returns of ambiguous securities through comparative statics of the SPD.

Does Smooth Ambiguity Matter for Asset Pricing?

We use the Bayesian method introduced by Gallant and McCulloch (2009) to estimate consumption-based asset pricing models featuring smooth ambiguity preferences. We rely on semi-nonparametric estimation of a flexible auxiliary model in our structural estimation. Based on the market and aggregate consumption data, our estimation provides statistical support for asset pricing models with smooth ambiguity. Statistical model comparison shows that models with ambiguity, learning and time-varying volatility are preferred to the long-run risk model. We analyze asset pricing implications of the estimated models.

The Impact of Overconfidence and Ambiguity Attitude on Market Entry

We study the behavioral drivers of market entry. An experiment allows us to disentangle the impact on entry across different types of markets of two key behavioral mechanisms: overconfidence and attitude toward ambiguity. We theorize and show that the causal effect of overconfidence on entry is limited to skill-based markets and does not appear in those that are chance based. Moreover, we also find that, independent of confidence levels, individuals exhibit ambiguity-seeking behavior when the result of the competition depends on their skills, which, in turn, leads to higher levels of entry. This preference for ambiguity thus can explain results that have previously been attributed to overconfidence. Our results challenge existing literature that has inferred overconfidence from differential entry levels across types of markets.

Departure time and route choices in bottleneck equilibrium under risk and ambiguity

This paper examines commuters’ departure time and route choices in the morning commute problem when a true distribution of travel time is unknown but belongs to a bounded distributional uncertainty set. The travel preferences towards risk and ambiguity are distinguished by adopting the criterion of ambiguity-aware Constant Absolute Risk Aversion (CARA) travel time. We first examine the dynamic user equilibrium for a single-route model with a homogeneous preference towards risk and ambiguity. Compared with risk-neutral commuters, we find that departure time window is shifted earlier for the risk-averse commuters and shifted later for the risk-seeking commuters. We also study the single bottleneck with a risk-averse class and a risk-seeking class. We show that with a larger gap between the two classes’ preferences, the congestion pattern will change from one peak to two peaks. It implies that preference heterogeneity may stagger the departure time choices and thereby relieve the average congestion. Last, we examine a two-route problem with homogeneous preference. Commuters choose between a fast and risky route (highway) and a slow and safe route (local arterial). We prove the monotonicity of the traffic flow distribution between the two routes with respect to the maximum variation in travel time. Furthermore, we find that reducing the uncertainty on the highway by providing information will reduce the total system cost and the total expected congestion simultaneously for risk-averse commuters. However, it will reduce the total expected congestion but increase the total system cost for risk-seeking commuters. In the numerical section, the price of anarchy is analyzed by varying the risk preference and the ambiguity preference.

Measuring higher order ambiguity preferences

We report the results from an experiment designed to measure attitudes towards ambiguity beyond ambiguity aversion. In particular, we implement recently-proposed model-free preference conditions of ambiguity prudence and ambiguity temperance. Ambiguity prudence has been shown to play an important role in precautionary behavior and the mere presence of ambiguity averse agents in markets. We observe that the majority of individuals’ decisions are consistent with ambiguity aversion, ambiguity prudence and ambiguity temperance. This finding confirms the prediction of many popular (specifications of) ambiguity models and has important implications for models of prevention behavior.

Modulating the Activity of the DLPFC and OFC Has Distinct Effects on Risk and Ambiguity Decision-Making: A tDCS Study.

Human beings are constantly exposed to two types of uncertainty situations, risk and ambiguity. Neuroscientific studies suggest that the dorsolateral prefrontal cortex (DLPFC) and the orbital frontal cortex (OFC) play significant roles in human decision making under uncertainty. We applied the transcranial direct current stimulation (tDCS) device to modulate the activity of participants’ DLPFC and OFC separately, comparing the causal relationships between people’s behaviors and the activity of the corresponding brain cortex when confronted with situations of risk and ambiguity. Our experiment employed a pre–post design and a risk/ambiguity decision-making task, from which we could calculate the preferences via an estimation model. We found evidences that modulating the activity of the DLPFC using right anodal/left cathodal tDCS significantly enhanced the participants’ preferences for risk, whereas modulating the activity of the OFC with right anodal/left cathodal tDCS significantly decreased the participants’ preferences for ambiguity. The reverse effects were also observed in the reversed tDCS treatments on the two areas. Our results suggest that decision-making processes under risk and ambiguity are complicated and may be encoded in two distinct circuits in our brains as the DLPFC primarily impacts decisions under risk whereas the OFC affects ambiguity.

Let the sunshine in? The effects of luminance on economic preferences, choice consistency and dominance violations.

Weather, in particular the intensity and duration of sunshine (luminance), has been shown to significantly affect financial markets. Yet, because of the complexity of market interactions we do not know how human behavior is affected by luminance in a way that could inform theoretical choice models. In this paper, we use data from a field study using an incentive-compatible, decision task conducted daily over a period of two years and from the US Earth System Research Laboratory luminance sensor to investigate the impact of luminance on risk preferences, ambiguity preferences, choice consistency and dominance violations. We find that luminance levels affect all of these. Age and gender influence the strength of some of these effects.

Learning-by-doing in an ambiguous environment

How well do revealed ambiguity preferences predict how people choose to seek new information about uncertain events? In an economics experiment, we apply a new instrument to measure ambiguity preferences, and in a later session observe to what extent the measure predicts the choice to receive costly information in a learning-by-doing game. Ambiguity averse subjects are more willing to pay to receive information, while risk averse subjects are not. Holding ambiguity preferences constant, risk averse subjects tend to perform worse than risk loving subjects. The returns to experimentation, especially for ambiguity averse subjects, suggest a not-well studied but important role that ambiguity preferences play in decision-making under uncertainty.

Consistency of Risk Preference Measures: An Artefactual Field Experiment from Rural China

ABSTRACTA variety of measures have been developed to elicit individual risk preferences. How these measures perform in the field, in particular in developing countries with non-student subjects, is still an open question. We implement an artefactual field experiment in rural China to investigate (i) consistency across incentivised experimental risk measures, (ii) consistency in risk preferences elicitation between non-incentivised survey measures and incentivised experiments, and (iii) possible explanations for risk preference inconsistency across measures. We find that inconsistent risk preferences across survey and experimental measures may be explained by ambiguity preferences. In the survey, subjects may mix risk and ambiguity preferences.

Corrigendum: Structural estimation of farmers’ risk and ambiguity preferences: a field experiment

Corrigendum: Structural estimation of farmers’ risk and ambiguity preferences: a field experiment

Structural estimation of farmers’ risk and ambiguity preferences: a field experiment

Ever since Ellsberg (1961), the distinction between risk, where agents assign well-defined probabilities to possible outcomes, and ambiguity, where agents do not, has been of particular interest. Using a carefully-designed field experiment, we elicit information about risk and ambiguity preferences among 197 French farmers and structurally estimate these preferences. e use cumulative prospect theory and a multiple-prior model in order to model risk and ambiguity preferences, respectively. We find that farmers are risk, ambiguity, and loss averse, and that probability distortion differs in gains vs. losses, as well as in risk vs. ambiguity. These findings can have important implications for policy design

AN ECONOMIC PREMIUM PRINCIPLE UNDER THE DUAL THEORY OF THE SMOOTH AMBIGUITY MODEL

AbstractThis study considers a pure exchange economy with insurance against ambiguous loss. Ambiguity preferences are represented by the dual theory of the smooth ambiguity model from Iwaki and Osaki (2014). The economic premium principle of Bühlmann (1980, 1984) is extended to ambiguity. We also perform some comparative statics and present sufficient conditions under which an increase in ambiguity aversion increases insurance demand and insurance premiums. Contrary to the result in Tsanakas and Christofides (2006), the optimal demand for insurance is not always comonotonic, because our model permits an economy comprising both ambiguity averse and ambiguity loving agents.

Voting in the limelight

When committees make decisions, voting rules are coupled with one of three disclosure rules: open voting, in which each committee member’s individual vote is revealed; anonymous voting, in which only an anonymized tally is publicized; and secret voting, in which only the outcome is disclosed. I focus on strategic voters who have a preference for strategic ambiguity, and show that the amount of disclosure may have a non-monotonic effect on both the accuracy of the decision and the welfare of the voters. In particular, anonymous voting can yield both lower accuracy and higher welfare than both open and secret voting.

The Identification of Attitudes towards Ambiguity and Risk from Asset Demand

Individuals behave differently when they know the objective probability of events and when they do not. The smooth ambiguity model accommodates both ambiguity (uncertainty) and risk. For an incomplete, competitive asset market, we develop a revealed preference test for asset demand to be consistent with the maximization of smooth ambiguity preferences; and we show that ambiguity preferences constructed from finite observations converge to underlying ambiguity preferences as observations become dense. Subsequently, we give sufficient conditions for the asset demand generated by smooth ambiguity preferences to identify the ambiguity and risk indices as well as the ambiguity probability measure. We do not require ambiguity beliefs to be observable: in a generalized specification, they may not even be defined. An ambiguity free asset plays an important role for identification.

Five-year-olds do not show ambiguity aversion in a risk and ambiguity task with physical objects

Ambiguity aversion arises when a decision maker prefers risky gambles with known probabilities over equivalent ambiguous gambles with unknown probabilities. This phenomenon has been consistently observed in adults across a large body of empirical work. Evaluating ambiguity aversion in young children, however, has posed methodological challenges because probabilistic representations appropriate for adults might not be understood by young children. Here, we established a novel method for representing risk and ambiguity with physical objects that overcomes previous methodological limitations and allows us to measure ambiguity aversion in young children. We found that individual 5-year-olds exhibited consistent choice preferences and, as a group, exhibited no ambiguity aversion in a task that evokes ambiguity aversion in adults. Across individuals, 5-year-olds exhibited greater variance in ambiguity preferences compared with adults tested under similar conditions. This suggests that ambiguity aversion is absent during early childhood and emerges over the course of development.

The Myth of Effective Veto Power under the Rule of Consensus. Dynamics and Democratic Legitimacy of Collective Decision-Making by “Tacit Consent”

Cette étude discute l’hypothèse courante selon laquelle la règle de décision par consensus, par laquelle les décisions sont prises par « consentement tacite », c’est-à-dire sans vote et en absence d’une dissidence ouverte, attribue un pouvoir de veto à chaque décideur. Elle aborde cette hypothèse d’un point de vue conceptuel, analytique et empirique et réévalue la valeur démocratique de cette règle de décision et son applicabilité empirique. L’argument principal de l’étude est que les options de veto sont restreintes par mille façons sous la règle du consensus, ce qui rend cette hypothèse du consentement trompeuse. Nous montrons que le pouvoir de veto en cas de décisions collectives prises selon la règle de consensus est limité par divers mécanismes et normes sociales, qu’il est en outre réparti de façon asymétrique parmi les décideurs, et en outre désactivé, dans une majorité de cas, par « l’ombre du vote majoritaire ». L’examen des dimensions de la légitimité démocratique en termes d’intrants et de résultats montre que l’égalité de participation et d’influence et les normes de transparence et de responsabilité sont violées en raison des options de la règle du veto et d’un ordre ambigu de préférences découlant de la logique particulière de cette règle de décision. L’efficacité de cette règle est néanmoins forte et l’engagement du groupe n’est pas inférieur à ce qu’on observe dans des situations où s’applique la règle du vote. Compte tenu des points forts et des points faibles de cette règle décisionnelle, sa pertinence dans divers contextes politiques est discutée.