Ambiguity Aversion and Incompleteness of Contractual Form

Posted: 15 May 1998

See all articles by Sujoy Mukerji

Sujoy Mukerji

Queen Mary University of London; International Centre for Economic Research (ICER)

Abstract

Subjective uncertainty is characterized by ambiguity if the decision maker has an imprecise knowledge of the probabilities of payoff relevant events. In such an instance, the decision maker's beliefs are better represented by a set of probability functions than by a unique probability function. An ambiguity averse decision maker adjusts his choice on the side of caution in response to his imprecise knowledge of the odds. The non-additive expected utility model allows a formal characterization of such behavior. Using this model, this paper shows that ambiguity aversion can explain the existence of incomplete contracts. The setting for the demonstration is the investment hold-up model which has been the focus of much of the recent research on the implications of incomplete contracts.

JEL Classification: D23, D8, L22

Suggested Citation

Mukerji, Sujoy, Ambiguity Aversion and Incompleteness of Contractual Form. American Economic Review. Available at SSRN: https://ssrn.com/abstract=87146

Sujoy Mukerji (Contact Author)

Queen Mary University of London ( email )

Mile End
Mile End Road
London, London E1 4NS
United Kingdom

International Centre for Economic Research (ICER)

Villa Gualino
Viale Settimio Severo, 63
10133 Torino
Italy

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