Nau risk ambiguity and state preference theory pdf

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Nau risk ambiguity and state preference theory pdf

Advanced Search Food-borne illness is recognized as a significant public health problem in the United States. Due to potential market failures associated with the provision of adequate levels of food safety, a number of regulatory mechanisms have been introduced over the years.

The bulk of current U. The introduction of the HACCP regulations has raised a plethora of new and difficult scientific and policy questions.

One of the most important problems is the assessment of food-borne hazards associated with various strategies to control food safety.

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Difficulties with food-borne risk assessment arise from imperfect hazard identification and inadequate scientific understanding of potential exposure and dose-response relationship 1 Antle In other words there is considerable scientific uncertainty about food-borne hazards.

Food Safety and Inspection Service FSIS and other government agencies have long recognized the need to properly address this uncertainty.

As a result, the existence of objective probabilities or the ability to determine informed subjective probabilities about food-borne hazards and the associated effects is at best problematic. The existing economics literature on food safety regulations largely ignores the crucial fact that food safety decisions are almost universally made under conditions of scientific uncertainty about food quality.

When the stochastic nature of the decision environment is recognized, existing studies of regulation of food-borne hazards rely exclusively on expected-utility theory, which, by its axiomatic construction, requires either that there exist known objective probabilities or that decision-makers can accurately form unique subjective probabilities.

Thus, existing models based on expected utility theory do not distinguish between decisions taken in the presence of Knightian risk known probabilities and decisions taken in the presence of Knightian uncertainty unknown probabilities.

We fill this gap in the literature on the economics of regulation of food-borne hazards by developing a model that distinguishes between risk known probabilities and ambiguity unknown probabilities.

This distinction dates to Keynes and Knight It has been relatively unnoticed until the seminal work by Ellsberg who has constructed experiments demonstrating that decision-makers exhibit behavior sensitive to the weight of evidence about probabilities.

Nau risk ambiguity and state preference theory pdf

Ellsberg-type behavior has been repeatedly and routinely validated in the experimental and empirical literatures see, e. The Model There are two parties to the contract, a regulator and a firm.

Risk, Ambiguity, and State-Preference Theory (2010)

The firm produces a food product of uncertain quality. For example, the regulator may test the food product to estimate its pathogen content. This, in turn, may allow the regulator to make inferences about the quality of the food product and the actions taken by the firm to improve food safety.

It is assumed that the regulator and the firm have identical beliefs about the states of Nature. We assume that the decision-makers do not perceive any ambiguity regarding the realizations of different signals: That is, the regulator and the firm may have multiple probabilities of the events representing safety of the food product.

That is, the lower upper probability is the smallest highest likelihood of the adverse outcome perceived by the decision-makers. Following Walleywe define degree of imprecision by.

Note that for some actions of interest the lower and upper probabilities may move in opposite directions as the firm switches from one action to another. The methodology developed in this paper can be successfully applied to these cases. However, we omit these scenarios due to space considerations.

To reduce the number of possible cases, we also assume that the cost of action is relatively high compared to the cost of action 5 The regulator observes a signal of quality and conditions payment to the firm on the realization of the signal.

It is assumed that 8.Ambiguity and Asset Markets. The claim is often based on examples with two states of the world, where MP preferences exhibit indifference curves that are kinked at certainty and smooth elsewhere. two manifestations of uncertainty are of major importance in economic theory: risk and ambiguity (Ellsberg , Hsu et al.

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Nau risk ambiguity and state preference theory pdf

Theory, Economic JournalEconomic Theory,, EURO Journal on Decision Processes, International Economic Review, International Journal of Approximate Reasoning, Journal of the American Statistical Association, Journal of Applied Econometrics, Journal of.

To distinguish the effects of risk (known probabilities) and ambiguity (unknown probabilities), state 2 is assigned an objectively known probability, whereas states 1 and 3 have ambiguous probabilities.

Decision-Making under Certainty, Risk and Uncertainty

ambiguous about the hidden state and his preferences are represented by a generalized recursive smooth ambiguity model that allows for a three-way separation among risk aversion, ambiguity aversion, and intertemporal substitution.

Preferences come from the most ubiquitous human activity: living with other people. Support for and opposition to different ways of life, the shared values legitimating social relations (here called cultures) are the generators of diverse preferences.

“Risk, Ambiguity and State-Preference Theory,” presented at the Workshop on Risk, Ambiguity, and Decisions in Honor of Daniel Ellsberg, Institute for Advanced Studies, Vienna, May ,

Bob Nau | Duke's Fuqua School of Business