Recursive expected utility and the separation of attitudes towards risk and ambiguity: an experimental study

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Abstract

We use the multiple price list method and a recursive expected utility theory of smooth ambiguity to separate out attitude towards risk from that towards ambiguity. Based on this separation, we investigate if there are differences in agent behaviour under uncertainty over gain amounts vis-a-vis uncertainty over loss amounts. On an aggregate level, we find that (i) subjects are risk averse over gains and risk seeking over losses, displaying a “reflection effect” and (ii) they are ambiguity neutral over gains and are mildly ambiguity seeking over losses. Further analysis shows that on an individual level, and with respect to both risky and ambiguous prospects, there is limited incidence of a reflection effect where subjects are risk/ambiguity averse (seeking) in gains and seeking (averse) in losses, though this incidence is higher for ambiguous prospects. A very high proportion of such cases of reflection exhibit risk (ambiguity) aversion in gains and risk (ambiguity) seeking in losses, with the reverse effect being significantly present in the case of risk but almost absent in case of ambiguity. Our results suggest that reflection across gains and losses is not a stable individual characteristic, but depends upon whether the form of uncertainty is precise or ambiguous, since we rarely find an individual who exhibits reflection in both risky and ambiguous prospects. We also find that correlations between attitudes towards risk and ambiguity were domain dependent.

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Correspondence to Jaideep Roy.

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Chakravarty, S., Roy, J. Recursive expected utility and the separation of attitudes towards risk and ambiguity: an experimental study. Theory Decis 66, 199 (2009). https://doi.org/10.1007/s11238-008-9112-4

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Keywords

  • Recursive expected utility
  • Risk
  • Ambiguity

JEL Classifications

  • C9
  • C44
  • C91