Updating ambiguity averse preferences

Alternatively, you can download the file locally and open with any standalone PDF reader: https://link.springer.com/content/pdf/10.1007/s11238-017-9611-2Ambiguity aversion under maximum-likelihood updating Daniel Heyen 0 0 Grantham Research Institute, London School of Economics , London , UK Maximum-likelihood updating (MLU) is a well-known approach for extending static ambiguity sensitive preferences to dynamic set-ups.

Rather, it results from MLU's selection of extreme priors, causing a violation of the stability of set inclusion over the course of the updating process.

To clarify this, the paper adopts the framework of Epstein and Schneider (2007) which respects dynamic consistency as well as consequentialism.1 The other reason to follow Epstein and Schneider (2007) is their explicit use of MLU.

Concrete, they adopt the generalized and less extreme MLU, already suggested by Gilboa and Schmeidler (1993), in which also priors that only “epsilon maximise the likelihood function” are updated.

The problematic feature of this example reveals is that, upon observing a draw from either urn, MLU can reverse both (1) and (2) despite the fact that the information provided by the draws was symmetric across urns and agents.

Rather, it results from MLU’s selection of extreme priors, causing a violation of the stability of set inclusion over the course of the updating process. If you do not see its contents the file may be temporarily unavailable at the journal website or you do not have a PDF plug-in installed and enabled in your browser.Its main contribution is to design and analyse a simple example to demonstrate that MLU suffers from unintuitive characteristics.The example revolves around two urns with unknown composition.This paper demonstrates that MLU, both in the strict and the generalized form, gives rise to the switch in betting preferences surrounding risky and ambiguous urns.The deeper reason is that MLU does not respect set inclusion stability over the course of the updating process. Section 2 presents the simple example in which exante and ex-post betting preferences are surprisingly unaligned. Apart from a white and a black ball, each urn contains a third ball that is either black or white.

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