Journal Article

Learning Under Ambiguity

Larry G. Epstein and Martin Schneider

in The Review of Economic Studies

Published on behalf of Review of Economic Studies Ltd

Volume 74, issue 4, pages 1275-1303
Published in print October 2007 | ISSN: 0034-6527
Published online October 2007 | e-ISSN: 1467-937X | DOI: http://dx.doi.org/10.1111/j.1467-937X.2007.00464.x
Learning Under Ambiguity

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This paper considers learning when the distinction between risk and ambiguity matters. It first describes thought experiments, dynamic variants of those provided by Ellsberg, that highlight a sense in which the Bayesian learning model is extreme—it models agents who are implausibly ambitious about what they can learn in complicated environments. The paper then provides a generalization of the Bayesian model that accommodates the intuitive choices in the thought experiments. In particular, the model allows decision-makers' confidence about the environment to change—along with beliefs—as they learn. A portfolio choice application compares the effect of changes in confidence under ambiguity vs. changes in estimation risk under Bayesian learning. The former is shown to induce a trend towards more stock market participation and investment even when the latter does not.

Keywords: D83

Journal Article.  14549 words.  Illustrated.

Subjects: Information, Knowledge, and Uncertainy

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