Decision Making Under Ambiguity

Abstract

Ellsberg's paradox demonstrates that ambiguous or vague probabilities derived from choices between gambles are not coherent. A descriptive model of judgement under ambiguity is developed in which an initial estimate serves as a starting point and adjustments are made for abbiguity. The adjustments involve a mental simulation in which higher and lower probabilities are considered and differentially weighted. Implications of this model include ambiguity avoidance and seeking; sub- and superadditivity of complementary probabilities; dynamic ambiguity; and reversals in the meaning of data. Three experiments involving Ellsberg's paradox and the setting of buying and selling prices for insurance and warranties test the model. A choice rule under ambiguity is developed that implies a lack of independence between ambiguous probabilities and the sign of payoff utility. The applicability of the model to the case where probabilities are explicitly stated is considered, including the handling of context effects. Keywords: Ambiguity, Decision making, Insurance.