Lotto lotteries — Decision making under uncertainty when payoffs are unknown

• Published in: Journal of behavioral and experimental economics Vol. 114; p. 102310
• Main Author: Schröder, David
• Format: Journal Article
• Language: English
• Published: Elsevier Inc 01.02.2025
• Subjects: Ambiguity aversion; Decision making; Lotteries; Risk aversion; Subjective expected utility; Uncertainty; Risk aversion; Ambiguity aversion; Uncertainty; Decision making; Subjective expected utility; C91; Lotteries; D81
• ISSN: 2214-8043
• DOI: 10.1016/j.socec.2024.102310

This paper analyses decision making under uncertainty when payoffs are unknown, similar to a Lotto lottery. In a Lotto lottery, the probability of winning a prize is known, but the size of the prize is unknown. This paper proposes a theoretical framework to model preferences over Lotto lotteries as compound lotteries. The first stage determines whether a prize is obtained, while the second stage determines the size of the prize. Then the paper empirically analyses human behaviour when uncertainty can be described as a Lotto lottery. There is considerable heterogeneity in the subjects’ aversion to lotteries with unknown payoffs. Further analysis shows that choices of decision makers can be best explained by a combination of risk and ambiguity preferences. These results suggest that subjects treat unknown payoffs similar to known payoffs with ambiguous probabilities. •This paper analyses decision making under uncertainty when payoffs are unknown.•Preferences over lotteries with unknown payoffs are modelled as compound lotteries.•The first stage decides if there is a payoff, and the second stage decides its size.•There is large heterogeneity in preferences over lotteries with unknown payoffs.•Uncertain payoffs are treated similar to known payoffs with uncertain probabilities.