Markets, Mechanism Design and Decision Theory

University Of California-Berkeley, Berkeley CA

Investigators

Abstract

Understanding decision making under uncertainty is one of the most important problems in economics. Economists and decision theorists have long sought to develop rigorous foundations for realistic models of how people perceive and respond to uncertainty. The expected utility theory has been the dominant paradigm for both theoretical and applied work incorporating uncertainty for over fifty years. However, there are serious shortcomings in this theory. For example, the well-known paradoxes of Allais and Ellsberg suggest that decision makers routinely and systematically violate expected utility axioms. These violations take the form of misinterpreting small probability events in the case of the Allais paradox, and failing to form a unique subjective prior and use it in a probabilistically sophisticated way in the case of Ellsberg's paradox. Similarly, Kahneman and Tversky's seminal work on prospect theory and loss aversion shows that decision makers often respond differently to losses than to gains. This project will study a variety of problems using models featuring ambiguity. Ambiguity appears when decision makers do not have a precise idea of the probability of the different possible outcomes of their decisions. The project will focus on developing mathematical techniques for describing individual's preferences in abstract choice problems. It will also analyze the implications of ambiguity on markets and on the design of incentive systems. Results will include a deeper understanding of the effects of uncertainty on important resource allocation mechanisms. These results will be useful to other scholars and to policymakers interested in a range of questions from the timing and structure of innovation to why people use relatively simple arrangements such as English auctions for buying and selling.