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Ambiguity aversion under maximum-likelihood updating

Heyen, Daniel (2018) Ambiguity aversion under maximum-likelihood updating. Theory and Decision, 84 (3). pp. 373-386. ISSN 0040-5833

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Identification Number: 10.1007/s11238-017-9611-2

Abstract

Maximum likelihood updating (MLU) is a well-known approach for extending static ambiguity sensitive preferences to dynamic set-ups. This paper develops an example in which MLU induces an ambiguity averse maxmin expected utility (MEU) decision-maker to (i) prefer a bet on an ambiguous over a risky urn and (ii) be more willing to bet on the ambiguous urn compared to an (ambiguity neutral) subjective expected utility (SEU) decision-maker. This is challenging since prior to observing (symmetric) draws from the urns, the MEU decision-maker (in line with the usual notion of ambiguity aversion) actually preferred the risky over the ambiguous bet and was less willing to bet on the ambiguous urn than the SEU decision-maker. The identified switch in betting preferences is not due to a violation of dynamic consistency or consequentialism. Rather, it results from MLU's selection of extreme priors, causing a violation of the stability of set-inclusion over the course of the updating process.

Item Type: Article
Official URL: https://link.springer.com/journal/11238
Additional Information: © 2017 The Author © CC BY 4.0
Subjects: H Social Sciences > HB Economic Theory
JEL classification: D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D81 - Criteria for Decision-Making under Risk and Uncertainty
D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D83 - Search; Learning; Information and Knowledge; Communication; Belief
Sets: Research centres and groups > Grantham Research Institute on Climate Change and the Environment
Date Deposited: 07 Jun 2017 13:33
Last Modified: 13 Jun 2018 10:14
Projects: GO 1604/2; HE 7551/1-1
Funders: German Research Foundation
URI: http://eprints.lse.ac.uk/id/eprint/80342

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