Track: Decision Sciences

Abstract

This paper examines whether individuals perceive benefits from diversification when prospects are ambiguous and how those benefits compare to analogous situations under risk. Based on Gilboa and Schmeidler’s (1989) maxmin expected utility model, the hypothesis is that only risk-seeking individuals would receive non-zero diversification benefits. In particular, these decision-makers would receive negative benefits from diversification that would increase in the gains domain and further decrease in the losses domain as the degree of ambiguity increases. Results from a series of experiments suggest that people may perceive less benefit from diversification under ambiguity than under risk. However, individuals tend to diversify over a greater number of prospects when the prospects are ambiguous than when they are risky. This may be due to people’s attempt to compensate for the lower marginal benefit of diversifying under ambiguity than under risk. It also implies a decrease in tolerance toward aleatory uncertainty in presence of epistemic uncertainty.