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A theory of subjective compound lotteries. (English) Zbl 1162.91331
Summary: We develop a Savage-type model of choice under uncertainty in which agents identify uncertain prospects with subjective compound lotteries. Our theory permits issue preference; that is, agents may not be indifferent among gambles that yield the same probability distribution if they depend on different issues. Hence, we establish subjective foundations for the Anscombe-Aumann framework and other models with two different types of probabilities. We define second-order risk as risk that resolves in the first stage of the compound lottery and show that uncertainty aversion implies aversion to second-order risk which implies issue preference and behavior consistent with the Ellsberg paradox.

MSC:
91B06 Decision theory
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