Could the unknown unknown be good or bad news? The role of valence in decision making under ambiguity

A number of self-serving biases have recently been explained by asymmetric belief updating under risk which asserts that humans are quick to learn from positive but not negative information. However, risky decisions in real life are often made under ambiguity where only partial information is available about distribution of risks. We demonstrate that under ambiguity, belief updating is not asymmetric but a flexible process of skepticism towards the valence of partially observable facts. When ambiguity size was tractable, belief updating was sensitive to valence: if the information was promising, ambiguity attitude decreased, skeptically balancing the promising prospects of available evidence against the hazards of what might be hidden from the view. Conversely, when the information was disappointing, attitude toward ambiguity increased, cautiously encouraging the participant to be more adventurous than what the available information guaranteed. These results go contradict the predictions from optimistic learning under risk and suggest that belief updating is sensitive to the state of our knowledge and ignorance.

Discriminating Between Models of Ambiguity Attitude: a Qualitative Test

During recent decades, many new models have emerged in pure and applied economic theory according to which agents’ choices may be sensitive to ambiguity in the uncertainty that faces them. The exchange between Epstein (2010) and Klibanoff et al. (2012) identified a notable behavioral issue that distinguishes sharply between two classes of models of ambiguity sensitivity that are importantly different. The two classes are exemplified by the α-maxmin expected utility (MEU) model and the smooth ambiguity model, respectively; and the issue is whether or not a desire to hedge independently resolving ambiguities contributes to an ambiguity-averse agent's preference for a randomized act. Building on this insight, we implement an experiment whose design provides a qualitative test that discriminates between the two classes of models. Among subjects identified as ambiguity sensitive, we find greater support for the class exemplified by the smooth ambiguity model; the relative support is stronger among subjects identified as ambiguity averse. This finding has implications for applications that rely on specific models of ambiguity preference.

Comparative Risk Aversion in the Presence of Ambiguity

This paper suggests a characterization of increases in risk aversion within the smooth ambiguity model by Klibanoff, Marinacci, and Mukerji (2005). I show that an increase in risk aversion is qualitatively different from that under expected utility, due to the incomplete separation between risk and ambiguity attitude. The analysis clarifies how ambiguity perception and attitude depend on risk aversion. (JEL D81)