Open AccessAllais, Ellsberg, and preferences for hedging
Author(s) -
Dean Mark,
Ortoleva Pietro
Publication year - 2017
Publication title -
theoretical economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 4.404
H-Index - 32
eISSN - 1555-7561
pISSN - 1933-6837
DOI - 10.3982/te1960
Subject(s) - ambiguity aversion , axiom , ambiguity , expected utility hypothesis , mathematical economics , preference , subjective expected utility , axiom independence , economics , prior probability , set (abstract data type) , econometrics , mathematics , microeconomics , computer science , bayesian probability , statistics , geometry , programming language
Two of the most well known regularities observed in preferences under risk and uncertainty are ambiguity aversion and the Allais paradox. We study the behavior of an agent who can display both tendencies simultaneously. We introduce a novel notion of preference for hedging that applies to both objective lotteries and uncertain acts. We show that this axiom, together with other standard ones, is equivalent to a representation in which the agent (i) evaluates ambiguity using multiple priors, as in the model of Gilboa and Schmeidler, 1989, and (ii) evaluates objective lotteries by distorting probabilities, as in the rank dependent utility model, but using the worst from a set of distortions. We show that a preference for hedging is not sufficient to guarantee Ellsberg‐like behavior if the agent violates expected utility for objective lotteries; we provide a novel axiom that characterizes this case, linking the distortions for objective and subjective bets.