Calendar
DR@W Forum - Mareile Drechsler (London School of Economics)
Title: Option Uncertainty Aversion - Predicting the Status Quo Bias
Abstract: In a Savage framework, this paper argues for the distinction between two types of uncertainty: ambiguity and option uncertainty. Under ambiguity the agent cannot assign unique prior probabilities to states of the world; this type of uncertainty explains, or predicts, the empirical observation of ambiguity averse preferences identified in the Ellsberg experiment (Ellsberg, 1961). Option uncertainty refers to decision problems where the state space is insufficiently fine-grained, such that consequences of acts at particular states are not unique; the agent can envisage several possible consequences at every state of the world. According to the so-called reduction argument, option uncertainty can be converted into ambiguity by refinement of the state space. We give (a) a theoretical argument against reduction, (b) support this claim with existing empirical evidence, and (c) suggest a direct test for reduction. Finally, option uncertainty aversion can serve as an explanation for the empirically observed status quo bias, under which agents express a preferences for the status quo over other available alternatives (Samuelson and Zeckhauser, 1988). We give a rational choice explanation for the status quo bias by deriving it from option uncertainty aversion; this constitutes an alternative to Kahneman, Knetsch and Thaler’s (1991) explanation of the status quo bias via loss aversion.