Ambiguity aversion under maximum-likelihood updating

Daniel Heyen

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: Maximum likelihood updating (MLU) is a well-known approach for extending static ambiguity sensitive preferences to dynamic set-ups. This paper develops an example in which MLU induces an ambiguity averse maxmin expected utility (MEU) decision-maker to (i) prefer a bet on an ambiguous over a risky urn and (ii) be more willing to bet on the ambiguous urn compared to an (ambiguity neutral) subjective expected utility (SEU) decision-maker. This is challenging since prior to observing (symmetric) draws from the urns, the MEU decision-maker (in line with the usual notion of ambiguity aversion) actually preferred the risky over the ambiguous bet and was less willing to bet on the ambiguous urn than the SEU decision-maker. The identified switch in betting preferences is not due to a violation of dynamic consistency or consequentialism. Rather, it results from MLU's selection of extreme priors, causing a violation of the stability of set-inclusion over the course of the updating process.

Keywords: learning under ambiguity; maxmin expected utility; ambiguity aversion; maximum likelihood updating; dynamic decision making; belief dynamics; Centre for Climate Change Economics and Policy (search for similar items in EconPapers)
JEL-codes: D81 D83 (search for similar items in EconPapers)
Date: 2018-05-01
New Economics Papers: this item is included in nep-mic and nep-upt
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Published in Theory and Decision, 1, May, 2018, 84(3), pp. 373-386. ISSN: 0040-5833

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