249
See also: Economic man 52–53 ■ Economic bubbles 98–99 ■ Risk and uncertainty 162–63 ■
Irrational decision making 194–95 ■ Behavioral economics 266–69
POST-WAR ECONOMICS
drawing on an idea originally
described by John Maynard Keynes
(p.161) in the 1930s.
Aversion to ambiguity
Ellsberg described a thought
experiment in which a cash prize
was offered if a ball of a particular
color was drawn from an imaginary
urn (see above). The bets made by
the experiment’s participants
demonstrated that people tend to
make a reasoned choice when
given some information from which
the degree of probability, and
therefore risk, can be assessed.
However, their behavior changes if
a future outcome seems
ambiguous, and this is the paradox
that departs from expected utility
theory. People prefer to know more
about the uncertainties they face,
rather than less. In the words of
former US Defense Secretary
Donald Rumsfeld (1932– ), people
prefer the “known unknowns” to
the “unknown unknowns.” The
outcome of the experiment has
been reproduced in several real
experiments since Ellsberg
published his paper. It
has become known as “ambiguity
aversion,” and sometimes
“Knightian uncertainty” after the
US economist Frank Knight (p.163).
In seeking to know more about
“unknown unknowns,” people may
act inconsistently with previous,
more logical choices, and put
questions of probability aside
when making their choice.Know the unknowns
Ellsberg’s paradox has proved
controversial. Some economists
claim that it can safely be
contained within conventional
theory, and that experimental
conditions do not properly
reproduce people’s behavior
when faced with real-life
ambiguity. However, the financial
crisis of 2008 has provoked
fresh interest in the problem
of ambiguity. People want to
know more about the unknown,
unquantifiable risks that expected
utility theory cannot account for. ■Daniel Ellsberg
Born in 1931, Daniel Ellsberg
studied economics at Harvard
University, and joined the US
Marine Corps in 1954. In 1959,
he became an analyst for the
White House. He received his
PhD in 1962, in which he first
presented his paradox.
Ellsberg, then working with
top security clearance, became
disillusioned with the Vietnam
War. In 1971, he leaked top
secret reports detailing the
Pentagon’s belief that the war
could not be won, before
handing himself over to the
authorities. His trial collapsed
when it was revealed that
White House agents had used
illegal wiretaps of his house.Key works1961 Risk, Ambiguity, and
the Savage Axioms
2001 Risk, Ambiguity, and
DecisionA further choice offered $100 if a red or yellow ball was
drawn, or $100 if a black or yellow was drawn. This time,
most players opted for black or yellow. In each case,
players showed a preference for known odds over
unknown odds.A probability experiment offered a choice of bets.
Players were told there were 30 red balls in an urn, together
with 60 balls that were an unspecified mixture of black and
yellow. Drawing a red ball would win $100; a black would
win $100. Most players opted for a bet on the red.