A theory of subjective compound lotteries

Haluk Ergin and Faruk Gul

Journal of Economic Theory, 2009, vol. 144, issue 3, pages 899-929

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: Compound; lottery; Second-order; probabilistic; sophistication; Uncertainty; aversion; Second-order; risk; aversion; Issue; preference; Ellsberg; paradox (search for similar items in EconPapers)
Date: 2009
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Persistent link: http://EconPapers.repec.org/RePEc:eee:jetheo:v:144:y:2009:i:3:p:899-929

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