Ambiguity Aversion and Epistemic Uncertainty

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