An Axiomatic Approach to Decision under Knightian Uncertainty

Description

Based on a set of seven axioms, we develop an original approach to utility under Knightian uncertainty that circumvents numerous conceptual problems of existing approaches in the literature. We understand and conceptualize Knightian uncertainty as income lotteries with known payos in each outcome, but unknown probabilities. This distinguishes our approach from the ambiguity approach where decision makers are assumed to have some sort of probabilistic belief about outcomes. We provide a proof that there exists a function H from the set of Knightian lotteries to the real numbers such that lottery f is preferred to lottery g if and only if H(f) > H(g) and that H is unique up to cardinal transformations. We propose and illustrate one possible concrete function satisfying our axioms with a static sample decision problem and compare it to other decision rules such as maximin, maximax, the Hurwicz criterion, the minimum regret rule and the principle of insucient reason. We nd that the overall ranking of the lotteries is dierent from these well-known criteria, but the most preferred option is the same as with the maximin rule and a pessimistic Hurwicz individual.

Period	15.02.2013
Event title	28th Annual Congress of the European Economic Association and 67th European Meeting of the Econometric Society - EEA 2013
Event type	Conference
Sponsors	European Economic Association, The Econometric Society
Location	Gothenburg, SwedenShow on map
Degree of Recognition	International