Lotto lotteries - Decision making under uncertainty when payoffs are unknown

42 Pages Posted: 16 Mar 2020 Last revised: 26 Jun 2020

See all articles by David Schröder

David Schröder

University of London - Birkbeck College

Date Written: June 24, 2020

Abstract

This paper analyses decision making under uncertainty when uncertain situations can be described as a Lotto lottery. In a Lotto lottery, the probability of winning a prize is objectively known, but the size of the prize is unknown. This paper first proposes a theoretical framework to model preferences over Lotto lotteries as compound lotteries. The first stage determines whether a prize is obtained, while the second stage determines the size of the prize. Second, the paper empirically analyses human behaviour when uncertainty can be described as a Lotto lottery. I find evidence for a mild degree of uncertainty aversion, i.e., subjects prefer lotteries with known prizes over lotteries with unknown prizes, everything else being equal. Further analysis shows that a combination of risk and ambiguity preferences can explain the subjects' uncertainty aversion.

Keywords: decision making, uncertainty, risk aversion, lotteries, ambiguity aversion, subjective expected utility, Anscombe-Aumann framework

JEL Classification: C91, D81

Suggested Citation

Schroeder, David, Lotto lotteries - Decision making under uncertainty when payoffs are unknown (June 24, 2020). Available at SSRN: https://ssrn.com/abstract=3541904 or http://dx.doi.org/10.2139/ssrn.3541904

David Schroeder (Contact Author)

University of London - Birkbeck College ( email )

Malet Street
London, WC1E 7HX
United Kingdom

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