First-Order and Second-Order Ambiguity Aversion

Matthias Lang

Management Science, 2017, vol. 63, issue 4, 1254-1269

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: ambiguity; uncertainty aversion; smooth ambiguity aversion; subjective beliefs; kinked preferences (search for similar items in EconPapers)
Date: 2017
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Citations: View citations in EconPapers (10)

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Related works:
Working Paper: First-Order and Second-Order Ambiguity Aversion (2015)
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Persistent link: https://EconPapers.repec.org/RePEc:inm:ormnsc:v:63:y:2017:i:4:p:1254-1269

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