Lotto lotteries - Decision making under uncertainty when payoffs are unknown
42 Pages Posted: 16 Mar 2020 Last revised: 26 Jun 2020
Date Written: June 24, 2020
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: Suggested Citation