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Prudence With Respect To Ambiguity

Authors


  • This article has greatly benefited from discussions with Louis Eeckhoudt, Richard Peter, Mark Machina, Sujoy Mukerji and Jean-Marc Tallon. Special thanks to Han Bleichrodt, Gijs van de Kuilen, Olivier L'Haridon, Harris Schlesinger and Peter P. Wakker for their many comments on previous drafts. This research was made possible by a Veni grant from the Netherlands Organisation for Scientific Research.

Abstract

Under expected utility, prudence is equivalent to a positive third derivative of utility and plays a crucial role in precautionary saving behaviour. Eeckhoudt and Schlesinger (2006) proposed behavioural definitions of prudence and of higher order risk preferences. The present article proposes a similar definition for prudence with respect to ambiguity, i.e. situations in which objective probabilities are not available. Implications for several ambiguity models are derived. Ambiguity prudence is implied by Hansen and Sargent's (2001) multiplier preferences, empirically correlates with financial behaviour and plays a key role in prevention behaviour.

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