Ambiguity Aversion

A nice quote from Stephen J. Dubner and Steven D. Levitt

[Frank Knight] made a distinction between two key factors in decision making: risk and uncertainty. The cardinal difference, Knight declared, is that risk — however great — can be measured, whereas uncertainty cannot.

How do people weigh risk versus uncertainty? Consider a famous experiment that illustrates what is known as the Ellsberg Paradox. There are two urns. The first urn, you are told, contains 50 red balls and 50 black balls. The second one also contains 100 red and black balls, but the number of each color is unknown. If your task is to pick a red ball out of either urn, which urn do you choose?

Most people pick the first urn, which suggests that they prefer a measurable risk to an immeasurable uncertainty. (This condition is known to economists as ambiguity aversion.) Could it be that nuclear energy, risks and all, is now seen as preferable to the uncertainties of global warming?

If you are interested in reading the late Frank Hyneman Knight‘s "Risk, Uncertainty & Profit", you can read it here.

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