## Abstract

The widely observed preference for lotteries involving precise rather than vague of ambiguous probabilities is called ambiguity aversion. Ambiguity aversion cannot be predicted or explained by conventional expected utility models. For the subjectively weighted linear utility (SWLU) model, we define both probability and payoff premiums for ambiguity, and introduce a local ambiguity aversion function a(u) that is proportional to these ambiguity premiums for small uncertainties. We show that one individual's ambiguity premiums are globally larger than another's if and only if his a(u) function is everywhere larger. Ambiguity aversion has been observed to increase 1) when the mean probability of gain increases and 2) when the mean probability of loss decreases. We show that such behavior is equivalent to a(u) increasing in both the gain and loss domains. Increasing ambiguity aversion also explains the observed excess of sellers' over buyers' prices for insurance against an ambiguous probability of loss.

Original language | English (US) |
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Pages (from-to) | 177-212 |

Number of pages | 36 |

Journal | Journal of Risk and Uncertainty |

Volume | 4 |

Issue number | 2 |

DOIs | |

State | Published - Apr 1991 |

## Keywords

- Ellsberg paradox
- ambiguity
- insurance prices
- nonlinear utility
- subjective probability

## ASJC Scopus subject areas

- Accounting
- Finance
- Economics and Econometrics