A survey of some applications of the idea of ambiguity aversion in economics

AbstractSubjective uncertainty is characterized by ambiguity if the decision maker has an imprecise knowledge of the probabilities of payoff relevant events. In such an instance, the decision maker's beliefs are better represented by a set of probability functions than by a unique probability function. An ambiguity averse decision maker adjusts his choice on the side of caution in response to his imprecise knowledge of the odds. This paper attempts a (selective) survey of some of the achievements of the research program which has analyzed important economic phenomena using a methodology that departs from standard paradigm by explicitly allowing for ambiguity aversion. We specifically look at applications, and implications, of ambiguity aversion in three areas: design of bilateral economic contracts, the trade in financial contracts and financial markets and finally, strategic decision making in auctions. We also indicate the possible relevance of these findings to recent research in AI