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Allais, Ellsberg, and preferences for hedging

Author

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  • Dean, Mark

    (Department of Economics, Columbia University)

  • Ortoleva, Pietro

    (Department of Economics, Columbia University)

Abstract
Two of the most well-known regularities observed in preferences under risk and uncertainty are ambiguity aversion and the Allais paradox. We study the behavior of an agent who can display both tendencies simultaneously. We introduce a novel notion of preference for hedging that applies to both objective lotteries and uncertain acts. We show that this axiom, together with other standard ones, is equivalent to a representation in which the agent 1) evaluates ambiguity using multiple priors, as in the model of Gilboa and Schmeidler [1989] and 2) evaluates objective lotteries by distorting probabilities, as in the Rank Dependent Utility model, but using the worst from a set of distortions. We show that a preference for hedging is not sufficient to guarantee Ellsberg-like behavior if the agent violates Expected Utility for objective lotteries; we provide a novel axiom that characterizes this case, linking the distortions for objective and subjective bets

Suggested Citation

  • Dean, Mark & Ortoleva, Pietro, 2017. "Allais, Ellsberg, and preferences for hedging," Theoretical Economics, Econometric Society, vol. 12(1), January.
    • Handle: RePEc:the:publsh:1960
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    More about this item

    Keywords

    Ambiguity aversion; Allais paradox; Ellsberg paradox; hedging; multiple priors; subjective mixture; probability weighting; rank dependent utility;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty

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