Decision Under Ambiguity via Intermediate Microeconomics
29 Pages Posted: 8 May 2019 Last revised: 30 Sep 2023
Date Written: September 25, 2023
Abstract
The goal of this paper is to present a unifying theory of decision-making under ambiguity. We present a theory that nests several of the existing models and captures special cases of others. Our theory requires no more technical background than found in intermediate microeconomics, and provides a natural interpretation of ambiguity attitude (it corresponds to a marginal rate of substitution). We illustrate the insights our model generates by applying it to a problem of lending with possible strategic default, in which the borrower’s future wealth is ambiguous. To show that our theory rests on a solid foundation, we then provide an axiomatization. To summarize, our model generalizes existing theories, has a low barrier to entry, and is straightforward to work with.
Keywords: ambiguity, pessimism, optimism, expected utility, costly state verification
JEL Classification: D80, D81
Suggested Citation: Suggested Citation