We provide a critical assessment of the ambiguity aversion literature, which we characterize in terms of the view that Ellsberg choices are rational responses to ambiguity, to be explained by relaxing Savage's Sure-Thing principle and adding an ambiguity-aversion postulate. First, admitting Ellsberg choices as rational leads to behaviour, such as sensitivity to irrelevant sunk cost, or aversion to information, which most economists would consider absurd or irrational. Second, we argue that the mathematical objects referred to as “beliefs” in the ambiguity (...) aversion literature have little to do with how an economist or game theorist understands and uses the concept. This is because of the lack of a useful notion of updating. Third, the anomaly of the Ellsberg choices can be explained simply and without tampering with the foundations of choice theory. These choices can arise when decision makers form heuristics that serve them well in real-life situations where odds are manipulable, and misapply them to experimental settings. (shrink)

A long tradition suggests a fundamental distinction between situations of risk, where true objective probabilities are known, and unmeasurable uncertainties where no such probabilities are given. This distinction can be captured in a Bayesian model where uncertainty is represented by the agent’s subjective belief over the parameter governing future income streams. Whether uncertainty reduces to ordinary risk depends on the agent’s ability to smooth consumption. Uncertainty can have a major behavioral and economic impact, including precautionary behavior that may appear overly (...) conservative to an outside observer. We argue that one of the main characteristics of uncertain beliefs is that they are not empirical, in the sense that they cannot be objectively tested to determine whether they are right or wrong. This can confound empirical methods that assume rational expectations. (shrink)

We provide a simple model to measure the impact of aggregate risks. We consider agents whose rankings of lotteries over vectors of outcomes satisfy expected utility and separability. Such rankings are characterized in terms of aggregative utilities that measure sensitivity to aggregate uncertainty in a straightforward way. We consider applications to models of product variety, portfolio choice, and public attitudes towards catastrophic risks. The framework lends support to precautionary measures that penalize policies for exposure to correlation. The model rationalizes a (...) number of behavioral and policy patterns as attempts to hedge against aggregate uncertainty. (shrink)

The pioneering contributions of Bewley, Gilboa and Schmeidler highlighted important weaknesses in the foundations of economics and game theory. The Bayesian methodology on which these fields are based does not answer such basic questions as what makes beliefs reasonable, or how agents should form beliefs and expectations. Providing the initial impetus for debating these issues is a contribution that will have the lasting value it deserves.