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A theory of subjective compound lotteries
Authors:Haluk Ergin
Institution:a Washington University in St. Louis, United States
b Department of Economics, Princeton University, Fisher Hall, Princeton, NJ 08544, United States
Abstract:We develop a Savage-type model of choice under uncertainty in which agents identify uncertain prospects with subjective compound lotteries. Our theory permits issue preference; that is, agents may not be indifferent among gambles that yield the same probability distribution if they depend on different issues. Hence, we establish subjective foundations for the Anscombe-Aumann framework and other models with two different types of probabilities. We define second-order risk as risk that resolves in the first stage of the compound lottery and show that uncertainty aversion implies aversion to second-order risk which implies issue preference and behavior consistent with the Ellsberg paradox.
Keywords:D81
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