Testing ambiguity theories with a mean-preserving design

Abstract

Prominent models such as MEU/α-MP and KMM interpret ambiguity aversion as aversion against second-order risks associated with ambiguous acts. We design an experiment where the decision maker draws twice with replacement in the typical Ellsberg two-color urns, but with a different color winning each time. Given this set of mean-preserving prospects, MEU/α-MP, KMM and Savage’s SEU all predict unequivocally that risk-averse DMs shall avoid the 50-50 urn that exhibits the highest risk conceivable, while risk-seeking ones do the opposite. However, we observe a substantial number of violations in the experiments. It appears that the ambiguity premium is partially paid to avoid the ambiguity issue per se, which is distinct from notions of second-order risk. This finding is robust even when there is only partial ambiguity.