“Ambiguity in the Economy and in Economics”

Abstract

S: INVITED SPEAKERS Luigi Guiso: The role of intuition and reasoning in driving aversion to risk and ambiguity Using a large sample of retail investors as well as experimental data we find that risk and ambiguity aversion are positively correlated. We provide correlational and causal evidence that a common link is decision mode: intuitive thinkers tolerate more risk and ambiguity than effortful reasoners. One interpretation is that intuitive thinking confers an advantage in risky or ambiguous situations. We present supporting lab and field evidence that intuitive thinkers outperform others in uncertain environments. Finally, we find that risk and ambiguity aversion vary with individual characteristics and wealth. The wealthy are less risk averse but more ambiguity averse, which has implications for financial puzzles. Peter Wakker: Using prospect theory to analyze new risks (ambiguity) in a large representative sample and to explain real investment decisions (joint with Mohammed Abdellaoui, Aurélien Baillon, & Laetitia Placido; and with Roy Kouwenberg & Steven Dimmock) Since Keynes (1921) & Knight (1921) we know that uncertainties in economics usually do not come with objective statistical probabilities. De Finetti (1931) and Savage (1954) proposed to still use probabilities in such cases, which then have to be subjective. However, Ellsberg (1961) showed that in most cases no subjective probabilities can be assigned in any traditional sense (ambiguity). Hence we need fundamentally new models. Only at the end of the 1980s, Gilboa & Schmeidler succeeded in introducing such models. The first ones were all theoretical and normatively motivated, assuming expected utility for known probabilities and focusing on ambiguity aversion. Tversky & Kahneman (1992) incorporated the Gilboa-Schmeidler ideas into prospect theory, leading to the first empirically realistic model of ambiguity. We introduce the source model, a special tractable version of prospect theory. It yields exact predictions and ambiguity premiums, and easy graphs to fully capture ambiguity attitudes. We can now let the data speak on ambiguity, showing a rich set of phenomena beyond the mere ambiguity aversion assumed in the normatively oriented theoretical models such as multiple priors, alpha-maxmin, and smooth utility. We first implement the source method in a laboratory experiment, and then in an incentivized survey over N=1,935 households, where we investigate the impact of ambiguity on household portfolio choices. In particular, we can now analyze the influence of ambiguity on the nonparticipation paradox of households that invest less in stocks than any normative theory can explain. Frans van Winden: Towards a new model of choice under uncertainty Humans appear to be very smart compared to other animals. Nevertheless, we mostly ‘muddle through’ in our decision-making because of the complexity of our environment and the very limited capacity of our brains. In this presentation I will plead for a new model of choice, incorporating greater input from neurobiology and psychology, to help organize the plethora of anomalies, aversions, and biases that we are witnessing in the literature and to get to better behavioral predictions. Dominic Bach: Ambiguity and the brain: a probabilistic perspective Neuroeconomic approaches to economic ambiguity have addressed two questions: how can neuroscience inform our understanding of ambiguity sensitivity; and what can we learn from the phenomenon of ambiguity sensitivity to better understand the brain. In my talk, I will cast economic ambiguity in terms of probabilistic brain function. Uncertainty about transition rules is an aspect of economic ambiguity that is prevalent in many areas of decision making and reinforcement learning. Rule certainty, in this framework, can usually only exist in the laboratory. I will review how rule uncertainty can be distilled from ambiguous situations, and how experimental paradigms and theoretical approaches can be finessed to further our understanding of how the organism deals with rule uncertainty. ABSTRACTS: POSTER SESSIONS: POSTER SESSION Daniel Roemer (University of Heidelberg) On the stability of ambiguity aversion The aversion of decision makers to ambiguity is a well studied concept, both in experiments and theory. Implicitly, to make predictions with these theories, one needs to assume that the attitude towards ambiguity is stable in some sense. In this paper we study stability of ambiguity attitudes in subsequent decisions. We use multiple three colour urns for our experiments. To observe two decisions on the same urn that do not include a hedging opportunity, we designed the following setup. In a first round, subjects are asked to make decisions for two three colour urns, only one of which is paid out. A coin flip determines which urn is paid. The other urn is transferred to the second round where subjects again make decisions for two urns. We compare decisions for the transferred urn in the first and second round to test stability of ambiguity attitudes for the same urn. We also test for stability across urns by comparing decisions within each round. Michael Roos (Ruhr-University Bochum) Payoff ambiguity in 2-player coordination games In an experiment, subjects play a modified stag-hunt coordination game. The game is modified by introducing ambiguity about the payoffs in the case of coordination failure. If the players do not coordinate, one of them receives either a high or a low payoff, which is determined randomly with a probability from a set of possible probabilities. The general goal of the paper is to observe how subjects behave under these conditions. I test whether they play according to a max-min strategy assuming the highest possible probability of the low payoff. The preliminary results reject the max-min hypothesis. They rather assume a central probability. Furthermore, subjects respond to higher ambiguity and higher potential losses by playing the safe action more frequently. Andreas Größler (Radboud University Nijmegen) Ambiguity of innovation effectiveness and its effect on intra-organisational diffusion processes The purpose of this study is to investigate how ambiguity in the perceived effectiveness of a process innovation influences the intra-organisational diffusion of this innovation. As methodology we employ a dynamic simulation model which is derived from two separate models described in the literature. The combined model represents innovation diffusion in and between five intra-organisational groups, where the diffusion influences improvement rates in the organisation and, thus, the perceived effectiveness of the innovation. At the same time, adoption of the innovation is dependent on bounded rational decisions of organisation members, based on the ambiguity they perceive regarding the effectiveness of the innovation. Simulation analyses indicate that the introduction of ambiguity can produce substantially different outcomes compared to models without this feedback structure. The study contributes to the innovation and organisation science literature by combining well-known models via a mechanism that explicitly includes ambiguity. The practical relevance of the research lies in the formulation of structural requirements for the successful diffusion of innovations in organisations. Sara Fogelberg (Stockholm University) Giving in ambiguous payoff environments This project investigates how social preferences extend to ambiguous decision environments. Inparticular, it explores the sensitivity of altruistic behavior to ambiguous environments in comparison to environments where the payoff for the recipient of altruistic giving is certain or associated with risk. Many real-life decisions involve uncertainty in which risks can at most be approximated. To account for this fact is of central importance when trying to extend experimental results to actual decision making. This issue applies to individual interactions in situations that are not covered by complete contracts or are subject to unpredictable changes in the environment, including decisions made on behalf of future generations and charitable donations. The project is thus also a case study of the more general question of how sensitive social preferences are to environmental conditions, which contributes to understanding the stability of individual preferences. Even though social preferences have been found to be an important aspect of economic behavior, it remains largely unexplored how social preferences extend to variation in the decision environment, most notably to the presence of uncertainty. In a dictator game experiment, we test for the effect of uncertain payoff environments on giving behavior by exposing the dictator’s contribution to different degrees of ambiguity and risk. Preliminary results show that dictators’ contributions decrease when the recipients payoff is associated with risk, and decreases even more when the recipient’s payoff is associated with ambiguity. Daniela Grieco (Bocconi University) Technological inertia and ambiguity Breakthrough innovations are an important engine of economic growth. However, technological refinements are much more frequent than disruptive patterns. Whereas incremental improvements deal with familiar technology and can be conceptualized as risky, radical breakthroughs imply ambiguous returns and innovator’s uncertainty about the model. The innovator’s attitude towards ambiguity could explain their conservative positions on existing products or technologies. We contrast traditional explanation based on convex adjustment costs and sunk costs inertia, and argue that technological conservativeness could be the result of an optimizing choice when breakthrough innovators are exposed to ambiguity. The innovator's choice between breakthrough and incremental innovations is analyzed in the context of a multiple-priors model (Gilboa and Schmeider, 1989). We di