An overview of economic applications of David Schmeidler`s models of decision making under uncertainty

This paper surveys some economic applications of the decision theoretic framework pioneered by David Schmeidler to model effects of ambiguity. We have organized the discussion principally around three themes: financial markets, contractual arrangements and game theory. The first section discusses papers that have contributed to a better understanding of financial market outcomes based on ambiguity aversion. The second section focusses on contractual arrangements and is divided into two sub-sections. The first sub-section reports research on optimal risk sharing arrangements, while in the second sub-section, discusses research on incentive contracts. The third section concentrates on strategic interaction and reviews several papers that have extended different game theoretic solution concepts to settings with ambiguity averse players. A final section deals with several contributions which while not dealing with ambiguity per se, are linked at a formal level, in terms of the pure mathematical structures involved, with Schmeidler`s models of decision making under ambiguity. These contributions involve issues such as, inequality measurement, intertemporal decision making and multi-attribute choice.Ellsberg Paradox, Ambiguity aversion, Uncertainty aversion

A reason for unreason: returns based beliefs in game theory

Players cooperate in experiments more than game theory would predict. We introduce the ‘returns-based beliefs’ approach: the expected returns of a particular strategy in proportion to total expected returns of all strategies. Using a decision analytic solution concept, Luce’s (1959) probabilistic choice model, and ‘hyperpriors’ for ambiguity in players’ cooperability, our approach explains empirical observations in various classes of games including the Prisoner’s and Traveler’s Dilemmas. Testing the closeness of fit of our model on Selten and Chmura (2008) data for completely mixed 2 × 2 games shows that with loss aversion, returns-based beliefs explain the data better than other equilibrium concepts

Investment Behavior under Ambiguity: The Case of Pessimistic Decision Makers

We define pessimistic, respectively optimistic, investors as CEU (Choquet expected utility) decision makers who update their pessimistic, respectively optimistic, beliefs according to a pessimistic (Dempster-Shafer), respectively optimistic, update rule. This paper then demonstrates that, in contrast to optimistic investors, pessimistic investors may strictly prefer investing in an illiquid asset to investing in a liquid asset. Key to our result is the dynamic inconsistency of CEU decision making, implying that a CEU decision maker ex ante prefers a different strategy with respect to prematurely liquidating an uncertain long-term investment project than after learning her liquidity needs. Investing in an illiquid asset then serves as a commitment device guaranteeing an ex ante favorable outcome.

Confidence and ambiguity

This paper proposes a model of the decision-maker’s confidence in his probability judgements, in terms of an implausibility measure – a real-valued function on the set of probability functions. A decision rule is axiomatised according to which the decision-maker evaluates acts using sets of probability functions which vary depending on the agent’s implausibility measure and on what is at stake in the choice of the act. The framework proposed yields a natural notion of comparative aversion to lack of confidence, or ambiguity aversion, and allows the definition of an ambiguity premium. It is shown that these notions are equivalent and can be characterised in terms of the implausibility measure representing the agent’s confidence. A simple portfolio example is presented.Confidence; multiple priors; ambiguity aversion; ambiguity premium; implausibility measure

The Value of a Statistical Life under Ambiguity Aversion

We show that ambiguity aversion increases the value of a statistical life as soon as the marginal utility of wealth is higher if alive than dead. The intuition is that ambiguity aversion has a similar effect as an increase in the perceived baseline mortality risk, and thus operates as the “dead anyway” effect. We suggest, however, that ambiguity aversion should usually have a modest effect on the prevention of ambiguous mortality risks within benefit-cost analysis, and can hardly justify the substantial “ambiguity premium” apparently embodied in environmental policy-making.ambiguity, value-of-a-statistical-life, uncertainty, risk-aversion, willingness-to-pay, benefit-cost analysis, environmental risk, health policy

Optimism and Pessimism in Games

This paper considers the impact of ambiguity in strategic situations. It extends the earlier literature by allowing for optimistic responses to ambiguity. Ambiguity is modelled by CEU preferences. We propose a new solution concept for players who may express ambiguity- preference. Then we study comparative statics of changes in ambiguity-attitude in games with strategic complements. This gives a precise statement of the impact of ambiguity on economic behaviour.Ambiguity in games, support, strategic complementarity, optimism, multiple equilibria.

Policy Evaluation in Uncertain Economic Environments

This paper develops a decision-theoretic approach to policy analysis. We argue that policy evaluation should be conducted on the basis of two factors: the policymaker's preferences, and the conditional distribution of the outcomes of interest given a policy and available information. From this perspective, the common practice of conditioning on a particular model is often inappropriate, since model uncertainty is an important element of policy evaluation. We advocate the use of model averaging to account for model uncertainty and show how it may be applied to policy evaluation exercises. We illustrate our approach with applications to monetary policy and to growth policy.

Decision-Making: A Neuroeconomic Perspective

This article introduces and discusses from a philosophical point of view the nascent field of neuroeconomics, which is the study of neural mechanisms involved in decision-making and their economic significance. Following a survey of the ways in which decision-making is usually construed in philosophy, economics and psychology, I review many important findings in neuroeconomics to show that they suggest a revised picture of decision-making and ourselves as choosing agents. Finally, I outline a neuroeconomic account of irrationality