This paper proposes a model of expected utility maximization which accounts for the Ellsberg paradox and for Machina’s extension of it. In the model, decision makers use a commutative ring in which the real numbers are embedded as a subring, and they do so in order to decompose their beliefs into ‘ambiguous’ or ‘unambiguous’ parts – with unambiguous beliefs being defined on the reals, and ambiguous beliefs defined otherwise. Decision makers whose beliefs are formed on the ring and who maximize expected utility on it, are then shown to behave in ways that are predicted by the Ellsberg paradox. The major paradoxical cases in Ellsberg’s seminal paper are resolved, along with some additional cases owed to Machina and Blavatskyy. Furthermore, it’s shown that Ellsberg’s reduced form solution to his own paradox is implied by the model.

Australian Conference of Economists 2015; Brisbane, Queensland; 2015-07-07 - 2015-07-10