Wednesday, June 03, 2009

An Experiment Protocol

1.0 Introduction
The point of the experiment described here is to offer empirical evidence for the importance of the distinction between uncertainty and risk, as put forth by Frank Knight and by John Maynard Keynes. People are not "rational", as "rationality" is defined by neoclassical economists.

As usual, I don't claim much originality except, maybe, in details. Daniel Ellsberg described the experiment below, as well as another. He references Chipman as having conducted experiments much like these. (Although Ellsberg's paper is oft cited and has been republished, Daniel Ellsberg is probably best known for having leaked The Pentagon Papers to the New York Times and others. Nixon's "plumbers" illegally broke into and searched Ellsberg's psychiatrist's office.)

2.0 The Protocol
The experimenter shows the test subject two urns, urn I and urn II. The test subject is shown that urn 1 is empty. The experimenter truthfully assures the test subject that urn II contains 8 balls, with some or none of them red and the remainder black. The test subject sees the experimented put one red and one black ball in urn II. The experimenter also puts in five red and five black balls in urn I in the test subject's presence. The urns are shaken.

So the test subject knows that urn number I contains 5 red and 5 black balls. Urn number II contains 10 balls. All are either red or black. At least one is black, and at least one is red.

The experimenter flips two coins so as to offer a gamble to the test subject. The coin flipping ensures the probability of offering each gamble is one in four. The gambles are described to the test subject:
  • Gamble A: You pay $5 for a draw from urn number I. You choose before the draw whether to play red or black. If a ball is drawn of your color, you receive a payout of $10.
  • Gamble B: You pay $5 for a draw from urn number II. You choose before the draw whether to play red or black. If a ball is drawn of your color, you receive a payout of $10.
  • Gamble C: You pay $5. You choose urn number I or urn number II. A ball is drawn from the urn you selected. If the ball is red, you receive $10.
  • Gamble D: You pay $5. You choose urn number I or urn number II. A ball is drawn from the urn you selected. If the ball is black, you receive $10.

Each test subject goes exactly once, and no test subject is able to observe previous plays by other test subjects (so urn number II cannot be sampled by a test subject).

The hypothesis is that in gambles A and B, statistically equal numbers of people will choose each color, while in gambles C and D, people will prefer to choose urn nmber I.

3.0 To Do
  • Demonstrate mathematically that no assignments of probability in urn number II are compatible with the hypothetical behavior.
  • Decide on a sample size. Perhaps a sequential test can be defined in which the sample size is not known beforehand.
  • Read Craig and Tversky (1995) and Chipman (1960). Where else is Ellsberg referenced?

References
  • J. S. Chipman, "Stochastic Choice and Subjective Probability", in Decisions, Values and Groups (edited by D. Willner), Pergamon Press (1960)
  • Daniel Ellsberg, "Risk, Ambiguity, and the Savage Axioms", Quarterly Journal of Economics, V. 75, N. 4 (Nov. 1961): 643-669
  • Craig R. Fox and Amos Tversky, "Ambiguity Aversion and Comparative Ignorance", Quarterly Journal of Economics, V. 110, N. 3 (1995): 585-603

2 comments:

Radek said...

Well, this may not be "neoclassical economics" for some definition of "neoclassical" but the Ellsberg paradox is definitely firmly within "mainstream economics" as your citations of Quarterly Journal of Economics (about as mainstream as you can get) exemplify.

james said...
This comment has been removed by a blog administrator.