Three Layers of Uncertainty: An Experiment

46 Pages Posted: 30 Jul 2018

See all articles by Ilke Aydogan

Ilke Aydogan

Bocconi University

Loic Berger

CNRS; IÉSEG School of Management, Lille Campus; RFF-CMCC European Institute on Economics and the Environment

Valentina Bosetti

Bocconi University; CMCC - Euro Mediterranean Centre for Climate Change

Ning Liu

Beihang University School of Economics and Management

Date Written: July 6, 2018

Abstract

We experimentally explore decision-making under uncertainty using a framework that decomposes uncertainty into three distinct layers: (1) physical uncertainty, entailing inherent randomness within a given probability model, (2) model uncertainty, entailing subjective uncertainty about the probability model to be used and (3) model misspecification, entailing uncertainty about the presence of the true probability model among the set of models considered. Using a new experimental design, we measure individual attitudes towards these different layers of uncertainty and study the distinct role of each of them in characterizing ambiguity attitudes. In addition to providing new insights into the underlying processes behind ambiguity aversion -failure to reduce compound probabilities or distinct attitudes towards unknown probabilities- our study provides the first empirical evidence for the intermediate role of model misspecification between model uncertainty and Ellsberg in decision-making under uncertainty.

Keywords: Ambiguity Aversion, Reduction of Compound Lotteries, Non-expected Utility, Model Uncertainty, Model Misspecification

JEL Classification: D81

Suggested Citation

Aydogan, Ilke and Berger, Loic and Bosetti, Valentina and Liu, Ning, Three Layers of Uncertainty: An Experiment (July 6, 2018). FEEM Working Paper No. 24.2018, Available at SSRN: https://ssrn.com/abstract=3209174 or http://dx.doi.org/10.2139/ssrn.3209174

Ilke Aydogan

Bocconi University ( email )

Via Sarfatti, 25
Milan, MI 20136
Italy

IÉSEG School of Management, Lille Campus ( email )

3 Rue de la Digue
Lille, 59000
France

RFF-CMCC European Institute on Economics and the Environment ( email )

Valentina Bosetti

Bocconi University

Via Gobbi 5
Milan, 20136
Italy

CMCC - Euro Mediterranean Centre for Climate Change

via Augusto Imperatore, 16
Lecce, I-73100
Italy

Ning Liu

Beihang University School of Economics and Management ( email )

New main building A1005, 37 Xueyuan Rd.
Beijing, Beijing 100191
China

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