Ellsberg`s 2-Color Experiment, Bid-Ask Behavior and Ambiguity
Sujoy Mukerji
Jean-Marc Tallon, CNRS-EUREQua, Universite Paris I
Abstract
Results in this note relate the observation of an interval of prices at which a DM strictly prefers to hold a zero position on an asset (termed `bid-ask behavior`) to the DM`s perception of the underlying payoff relevant events as ambiguous, as the term is defined in Epstein and Zhang (2001). The connection between bid-ask behavior and ambiguity is established without invoking a parametric preference form, such as the Choquet expected utility or the max-min multiple priors model. This allows us to draw an observable distinction between bid-ask behavior that may arise purely due to first-order risk aversion type effects, such as those which could arise even if preferences were probabilistically sophisticated, and the bid-ask behavior that involve ambiguity perceptions.
Keywords: Ellsberg Paradox, bid-ask spread, testing for ambiguity aversion, uncertainty aversion, unforeseen cointingencies, subjective state spaces.
Date: July 2002 | Reference number(s): 114
Series: Department of Economics Discussion Paper Series
JEL Classifications: D810