Ambiguity Aversion and Epistemic Uncertainty

43 Pages Posted: 16 Sep 2021

See all articles by Craig R. Fox

Craig R. Fox

University of California, Los Angeles (UCLA) - Anderson School of Management

Michael Goedde-Menke

University of Münster - Finance Center Münster

David Tannenbaum

University of Utah - Department of Management

Date Written: September 8, 2021

Abstract

We propose that ambiguity aversion reflects distaste for betting on one’s relative ignorance, but only to the extent that uncertainty is seen as inherently knowable (epistemic). In contrast, uncertainty viewed as random (aleatory) can provide an attractive hedge against betting on one’s ignorance. We refer to this account as the epistemic uncertainty aversion hypothesis, which allows for the simultaneous observation of ambiguity aversion and preference for compound lotteries involving both chance and ambiguity. In preregistered experiments involving Ellsberg urns and naturalistic events we show: (1) under conditions of ignorance, ambiguity averse decision makers prefer betting on a greater balance of aleatory to epistemic uncertainty; (2) this preference for an aleatory hedge increases as subjective knowledge decreases, and can lead decision makers to choose stochastically dominated alternatives; (3) an uncertain prospect can be framed as more epistemic or aleatory to influence its overall attractiveness. These findings collectively violate several prominent models of ambiguity aversion, but can be accomodated by generic source models.

Keywords: Ellsberg paradox, risk, ambiguity, epistemic uncertainty, aleatory uncertainty

JEL Classification: C91, D81, D91

Suggested Citation

Fox, Craig R. and Goedde-Menke, Michael and Tannenbaum, David, Ambiguity Aversion and Epistemic Uncertainty (September 8, 2021). Available at SSRN: https://ssrn.com/abstract=3922716 or http://dx.doi.org/10.2139/ssrn.3922716

Craig R. Fox (Contact Author)

University of California, Los Angeles (UCLA) - Anderson School of Management ( email )

110 Westwood Plaza
Los Angeles, CA 90095-1481
United States

Michael Goedde-Menke

University of Münster - Finance Center Münster ( email )

Universitätsstraße 14-16
Münster, 48143
Germany

David Tannenbaum

University of Utah - Department of Management ( email )

Salt Lake City, UT 84112
United States

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