A dual approach to ambiguity aversion |
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| Affiliation: | Chair of Integrative Risk Management and Economics at ETH Zurich, Switzerland;University of California, Berkeley, Department of Mathematics, Berkeley, CA 94720-5800, United States;University of the Basque Country (UPV/EHU) and BRiDGE Group, Department of Foundations of Economic Analysis I, Avenida Lehendakari Agirre 83, 48015, Bilbao, Spain;Institute of Social Science, University of Tokyo, 7-3-1, Hongo, Bunkyo-ku, Tokyo 113-0033, Japan;Woodrow Wilson School of Public and International Affairs, Princeton University, Robertson Hall, 20 Prospect Ave, Princeton, NJ 08540, United States;FGV/EPGE - Escola Brasileira de Economia e Finanças, Praia de Botafogo 190/1119B, Rio de Janeiro, RJ (22250-900), Brazil;Wang Yanan Institute for Studies in Economics (WISE), Xiamen University, Xiamen, 361005, China;College of Management, University of Massachusetts Boston, 100 Morrissey Boulevard, Boston, MA 02125, United States |
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| Abstract: | In the present paper, the assumption of monotonicity of Anscombe and Aumann (1963) is replaced by an assumption of monotonicity with respect to first-order stochastic dominance. This yields a representation result where ambiguous distributions of objective beliefs are first aggregated into “equivalent unambiguous beliefs” and then risk preferences are used to compute the utility of these equivalent unambiguous beliefs. Such an approach makes it possible to disentangle uncertainty aversion, related to the processing of information, from risk aversion, related to the evaluation of the equivalent unambiguous beliefs. An application to portfolio choice shows the tractability of the framework and its intuitive appeal. |
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| Keywords: | Ambiguity aversion First-order stochastic dominance Separability Comonotonic sure-thing principle Rank-dependent utility Portfolio choice |
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