Risk uncertainty and ambiguity
Source: SFB 504
Many different definitions of risk, uncertainty, and ambiguity can be found
in the literature. This entry follows the notion commonly used in modern
decision theory, e.g. employed by Tversky and Kahneman (1992)
and much earlier proposed by Knight (1921).
Camerer and Weber (1992)
provide a review of various definitions and formalizations.
A decision is called risky when the
probabilities that certain states will occur in the future are precisely
known, e.g. in a fair roulette game. In contrast, a decision is called
uncertain when the probabilities are not precisely known. Examples are the
outcomes of sports events, elections or most real investments. Decisions
under risk can be seen as a special case of decisions under uncertainty with
precisely known probabilities. Risk and uncertainty can be distinguished by
the degree with which probabilities are known. In case of uncertainty,
probabilities are not precisely known but people can form more or less vage
beliefs about probabilities. If people are definitely not able to form any
beliefs about probabilities, this special case is termed complete ignorance.
The above notion of uncertainty corresponds to the widely used term
ambiguity.
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