Friday, August 10, 2018

Chen and Schonger (2016) on Ambiguity Aversion

Daniel L. Chen and Martin Schonger, “Is Ambiguity Aversion a Preference?” TSE Working Paper No. 16-703, December 2016.

Ambiguity aversion has been implicated in many real world phenomena, including the equity premium puzzle: the stock market operates under Knightian uncertainty (ambiguity), not risk, and so ambiguity-averse investors need compensation to buy stocks. Overly punitive plea bargains are acceptable to ambiguity-averse defendants…

• But perhaps the sort of behavior exhibited by the Ellsberg paradox is not really indicative of underlying preferences – perhaps it is mistake, the use of a decision heuristic in inappropriate circumstances. Perhaps people are not actually ambiguity averse.

• Maybe people (rightly) shy away from unfamiliar offers, especially when the person making the offer possesses superior information – and this is the situation when experimental participants are presented with the Ellsberg game. Subjects suspect that the experimenter actually knows how many red and blue balls are in the urn.

• Chen and Schonger set up an Ellsberg experiment where the experimenter is not the party responsible for the contents of the ambiguous urn; rather, the choices of other subjects determine the contents. 

• Every subject decides which of two symbols to send to the others. In experiment 1, the symbol that gets the most “votes” is the symbol that will appear in the “ambiguous” urn for other participants (which need not be the same for all participants, incidentally). 

• All experiments involve a toss of a fair coin, where the subjects can choose to bet on either heads or tails, along with the two ambiguous options. A correct outcome yields 4€. The choice of the bet is determined by taking the maximum of the valuations provided by each participant for each of the four bets. 

• People turn out to prefer the ambiguous bets! “For each of the 16 sessions, individuals were more likely to bet on a symbol with subjective uncertainty, and in all but 2 of the 16 sessions, both bets with subjective uncertainty were more popular than the bets with objective uncertainty [p. 15].” This remains true in design 2, where there is a full-on urn and not just a specific symbol chosen by others.

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