A theory of subjective compound lotteries

Haluk Ergin, Faruk Gul

Research output: Contribution to journalArticle

100 Scopus citations

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.

Original languageEnglish (US)
Pages (from-to)899-929
Number of pages31
JournalJournal of Economic Theory
Volume144
Issue number3
DOIs
StatePublished - May 1 2009

All Science Journal Classification (ASJC) codes

  • Economics and Econometrics

Keywords

  • Compound lottery
  • Ellsberg paradox
  • Issue preference
  • Second-order probabilistic sophistication
  • Second-order risk aversion
  • Uncertainty aversion

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