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Anticipated regret as an explanation of uncertainty aversion

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Abstract

The paper provides a psychological explanation of uncertainty aversion based on the fear of regret. We capture an agent’s regret using a reference-dependent utility function in which the agent’s utility depends on the performance of his chosen option relative to the performance of the option that would have been best ex post. An uncertain option is represented as a compound lottery. The basic idea is that selecting a compound lottery reveals information, which alters the ex post assessment of what the best choice would have been, inducing regret. We provide sufficient conditions under which regret implies uncertainty aversion in the sense of quasi-concave preferences over compound lotteries.

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Correspondence to Daniel Krähmer.

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We would like to thank an anonymous referee and the editor for useful comments. We also thank Florian Englmaier, Paul Heidhues, Rudolf Kerschbamer, Frank Riedel, Karl Schlag and seminar audiences in Bonn and Innsbruck for helpful suggestions and discussions. Krähmer acknowledges financial support through research grant SFB/TR 15.

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Krähmer, D., Stone, R. Anticipated regret as an explanation of uncertainty aversion. Econ Theory 52, 709–728 (2013). https://doi.org/10.1007/s00199-011-0661-3

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