First-Order and Second-Order Ambiguity Aversion

Matthias Lang

No 2015_13, Discussion Paper Series of the Max Planck Institute for Research on Collective Goods from Max Planck Institute for Research on Collective Goods

Abstract: Different models of uncertainty aversion imply strikingly different economic behavior. The key to understanding these differences lies in the dichotomy between first-order and second-order ambiguity aversion which I define here. My definition and its characterization are independent of specific representations of decisions under uncertainty. I show that with second-order ambiguity aversion a positive exposure to ambiguity is optimal if and only if there is a subjective belief such that the act’s expected outcome is positive. With first-order ambiguity aversion, zero exposure to ambiguity can be optimal. Examples in finance, insurance and contracting demonstrate the economic relevance of this dichotomy.

Keywords: Uncertainty Aversion; Ambiguity; Smooth Ambiguity Aversion; Sub-jective Beliefs; Kinked preferences (search for similar items in EconPapers)
JEL-codes: D01 D81 D82 G11 (search for similar items in EconPapers)
Date: 2015-09
New Economics Papers: this item is included in nep-cta, nep-mic and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

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Related works:
Journal Article: First-Order and Second-Order Ambiguity Aversion (2017)
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Persistent link: https://EconPapers.repec.org/RePEc:mpg:wpaper:2015_13

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