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Three layers of uncertainty and the role of model misspecification

Ilke Aydogan (), Loïc Berger, Valentina Bosetti () and Ning Liu
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Ilke Aydogan: IÉSEG School Of Management [Puteaux]
Ning Liu: Beihang University

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Abstract: We explore decision-making under uncertainty using a framework that decomposes uncertainty into three distinct layers: (1) risk, which entails inherent randomness within a given probability model; (2) model uncertainty, which entails subjective uncertainty about the probability model to be used; and (3) model misspecification, which entails uncertainty about the presence of the correct probability model among the set of models considered. Using a new experimental design, we measure individual attitudes towards these di↵erent layers of uncertainty and examine the role of each of them in characterizing attitudes towards ambiguity. In addition to providing new insights into the underlying processes behind ambiguity aversion, our study provides the first empirical evidence of the role of model misspecification in decision-making under uncertainty.

Keywords: Ambiguity aversion; model uncertainty; model misspecification; non-expected utility; reduction of compound lotteries (search for similar items in EconPapers)
Date: 2020-11-30
New Economics Papers: this item is included in nep-hpe and nep-upt
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