Testing Ambiguity Theories with a Mean-Preserving Design
37 Pages Posted: 26 Jan 2011 Last revised: 29 May 2014
Date Written: May 1, 2014
Prominent models such as MEU/α-MP and KMM interpret ambiguity aversion as aversion against second-order risks associated with ambiguous acts. We design an experiment where the decision maker draws twice with replacement in the typical Ellsberg two-color urns, but with a different color winning each time. Given this set of mean-preserving prospects, MEU/α-MP, KMM and Savage’s SEU all predict unequivocally that risk-averse DMs shall avoid the 50-50 urn that exhibits the highest risk conceivable, while risk-seeking ones do the opposite. However, we observe a substantial number of violations in the experiments. It appears that the ambiguity premium is partially paid to avoid the ambiguity issue per se, which is distinct from notions of second-order risk. This finding is robust even when there is only partial ambiguity.
Keywords: Ambiguity, Ellsberg paradox, expected utility, experiment, mean preserving, partial ambiguity, second-order risk, source premium
JEL Classification: C91, D81
Suggested Citation: Suggested Citation