Ambiguity (uncertainty) aversion

>>>Ambiguity (uncertainty) aversion
Ambiguity (uncertainty) aversion2018-07-08T13:25:26+00:00

Ambiguity aversion, or uncertainty aversion, is the tendency to favor the known over the unknown, including known risks over unknown risks. For example, when choosing between two bets, we are more likely to choose the bet for which we know the odds, even if the odds are poor, than the one for which we don’t know the odds.

This aversion has gained attention through the Ellsberg Paradox (Ellsberg, 1961). Suppose there are two bags each with a mixture of 100 red and black balls. A decision-maker is asked to draw a ball from one of two bags with the chance to win $100 if red is drawn. In one bag, the decision-maker knows that exactly half of the pieces are red and half are black. The color mixture of pieces in the second bag is unknown. Due to ambiguity aversion, decision-makers would favor drawing from the bag with the known mixture than the one with the unknown mixture (Ellsberg, 1961). This occurs despite the fact that people would, on average, bet on red or black equally if they were presented with just one bag containing either the known 50-50 mixture or a bag with the unknown mixture.

Ambiguity aversion has also been documented in real-life situations. For example, it leads people to avoid participating in the stock market, which has unknown risks (Easley & O’Hara, 2009), and to avoid certain medical treatments when the risks are less known (Berger, et al., 2013).

Berger, L., Bleichrodt, H., & Eeckhoudt, L. (2013). Treatment decisions under ambiguity. Journal of Health Economics, 32, 559-569.

Easley, D., & O’Hara, M. (2009). Ambiguity and nonparticipation: the role of regulation. The Review of Financial Studies, 22(5), 1817-1843.

Ellsberg, D. (1961). Risk, ambiguity, and the savage axioms. The Quarterly Journal of Economics, 75(4), 643-669.

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