IMPRECISE PROBABILITIES AND THEIR APPLICATIONS

26 - 29 June 2001

Aversion to uncertainty is commonly attributed to non-additivity of subjective probabilities for ambiguous events, as in the Choquet expected utility model. This paper shows that uncertainty aversion can be parsimoniously explained by a simple model of ?partially separable? non-expected utility preferences in which the decision maker satisfies the independence axiom selectively within partitions of the state space whose elements have similar degrees of uncertainty. As such, she may behave like an expected-utility maximizer with additive probabilities for assets in the same uncertainty class, while exhibiting higher degrees of risk aversion toward assets that are more uncertain. An alternative interpretation of the same model is that the decision maker may be uncertain about her credal state (represented by second-order probabilities for her first-order probabilities and utilities), and she may be averse to that uncertainty (represented by a second-order utility function). The Ellsberg and Allais paradoxes are explained by way of illustration.

** Keywords. ** risk aversion, uncertainty aversion, non-additive probabilities, risk neutral probabilities

** Format. **PDF

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** Authors addresses: **

Fuqua School of Business

Duke University

Durham, NC 27708-0120

USA

** E-mail addresses: **

Robert Nau | robert.nau@duke.edu |

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