Uncertainty and compound lotteries: calibration

Halevy, Y and Ozdenoren, E (2022) Uncertainty and compound lotteries: calibration. Economic Theory, 74. pp. 373-395. ISSN 0938-2259

Abstract

This paper introduces a theoretical model of decision making in which preferences are defined on both Savage subjective acts and compound objective lotteries. Preferences are two-stage probabilistically sophisticated when the ranking of acts corresponds to the ranking of the respective compound lotteries induced by the acts through the decision maker’s subjective belief. This family of preferences includes various theoretical models proposed in the literature to accommodate non-neutral attitude towards ambiguity. The principle of calibration relates preferences over acts and compound objective lotteries, and provides a foundation for the tight empirical association between probabilistic sophistication and reduction of compound lotteries for all two-stage probabilistically sophisticated preferences.