Testing Ambiguity Theories with a Mean-Preserving Design

37 Pages Posted: 26 Jan 2011 Last revised: 29 May 2014

See all articles by Chun-Lei Yang

Chun-Lei Yang

Lan Yao

Shanghai University of Finance and Economics

Date Written: May 1, 2014

Abstract

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

Yang, Chun-Lei and Yao, Lan, Testing Ambiguity Theories with a Mean-Preserving Design (May 1, 2014). Available at SSRN: https://ssrn.com/abstract=1747801 or http://dx.doi.org/10.2139/ssrn.1747801

Lan Yao

Shanghai University of Finance and Economics ( email )

777 Guoding Road
Shanghai, AK Shanghai 200433
China

HOME PAGE: http://se.shufe.edu.cn/structure/econ/people/faz_30133_1.htm

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