A theoretical foundation of ambiguity measurement

Yehuda Izhakian

Journal of Economic Theory, 2020, vol. 187, issue C

Abstract: Ordering alternatives by their degree of ambiguity is crucial in economic and financial decision-making processes. To quantify the degree of ambiguity, this paper introduces an empirically-applicable, outcome-independent (up to a state space partition), risk-independent, and attitude-independent measure of ambiguity. In the presence of ambiguity, the Bayesian approach can be extended to uncertain probabilities such that aversion to ambiguity is defined as aversion to mean-preserving spreads in these probabilities. Thereby, the degree of ambiguity can be measured by the volatility of probabilities, just as the degree of risk can be measured by the volatility of outcomes. The applicability of this measure is demonstrated by incorporating ambiguity into an asset pricing model.

Keywords: Ambiguity index; Knightian uncertainty; Ambiguity aversion; Uncertain probabilities; Perceived probabilities; Ambiguity premium (search for similar items in EconPapers)
JEL-codes: D81 D83 G11 G12 (search for similar items in EconPapers)
Date: 2020
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (33)

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S0022053120300090
Full text for ScienceDirect subscribers only

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eee:jetheo:v:187:y:2020:i:c:s0022053120300090

DOI: 10.1016/j.jet.2020.105001

Access Statistics for this article

Journal of Economic Theory is currently edited by A. Lizzeri and K. Shell

More articles in Journal of Economic Theory from Elsevier
Bibliographic data for series maintained by Catherine Liu ().