Ellsberg's Hidden Paradox

Abstract

Ellsberg (1961) proposes two alternative frames to elicit individuals' preferences for ambiguity. Through an experiment, we find that Ellsberg's three-color one-urn frame induces very different revealed preferences than the two-color two-urn frame. In both frames, we document ambiguity aversion for likely gains and (weak) ambiguity seeking for unlikely gains. The intensity of both these attitudes, however, is strongly curbed in the three-color frame. These findings may imply that perceived probabilities are biased toward uniformly distributed states and consequences, introducing a tension between them in the three-color frame. Surprisingly, we find that subjects who are simply asked to fill urns with colored bingo chips for a fixed payment also reveal a similar uniformity bias. We argue that both urn fillers and incentivized decision makers are influenced by similar perceptually salient features of probability intervals. Our findings have important implications for decision theory, and, by extension, for economic, financial, political, and medical decisions.

Keywords: Perceived probabilities, ambiguity, Knightian uncertainty, experiment, framing, judgment and decision making

JEL Classification: C91, D81, D91