CFDP 1667R

Affective Decision Making and the Ellsberg Paradox

Author(s): 

Publication Date: June 2008

Revision Date: August 2008

Pages: 19

Abstract: 

Affective decision-making is a strategic model of choice under risk and uncertainty where we posit two cognitive processes — the “rational” and the “emotional” process. Observed choice is the result of equilibrium in this intrapersonal game.

As an example, we present applications of affective decision-making in insurance markets, where the risk perceptions of consumers are endogenous. We derive the axiomatic foundation of affective decision making, and show that affective decision making is a model of ambiguity-seeking behavior consistent with the Ellsberg paradox.

Keywords: 

Affective choice, Endogenous risk perception, Insurance, Ellsberg paradox, Variational preferences, Ambiguity-seeking

JEL Classification Codes: D01, D81, G22