Three experiments on decision-making under uncertainty in dynamic environments

This dissertation consists of three economic experiments that investigate behavioral differences in decision making process under risk (uncertainty with known probabilities) and under ambiguity (uncertainty with unknown probabilities). The first and the second chapters present two experiments with subjects choosing between lotteries involving risky and ambiguous urns. Decisions are made in conjunction with a sequence of random draws with replacement, allowing us to track the beliefs of the agents at different moments in time. In the first chapter, we develop and estimate a model of subjective belief updating allowing for base rate fallacy. We find that when updating under ambiguity subjects significantly underweight the new signal, while when updating under compound risk subjects are essentially Bayesian. In the second chapter, we estimate a popular multiple priors model for decision making under ambiguity in dynamic environments. Our estimates suggest a difference in the confidence with which subjects discard the unlikely priors depending on whether an ambiguous urn was presented first or second. Specifically, when an ambiguous urn is presented first, subjects consider more priors during the learning process as compared to when a compound urn is presented first. We also find significant evidence against the hypothesis that human subjects consider only Dirac priors. In the third chapter, we examine the behavior of security dealers in an environment where the level of asymmetric information is viewed as either risk, compound risk, or ambiguity. Using two measures of market liquidity, resiliency and price, we find that duopoly dealer markets are both more resilient to uncertainty about asymmetric information as well as having higher dealer bids compared with monopoly dealer markets for all three uncertainty scenarios. Additionally, we find differences in dealer bidding behavior in duopoly setting depending on whether the uncertainty about informed trading is presented as risk, compound risk, or ambiguity.