Modeling Ambiguity Averse Behavior of Individual Decision Making: Prospect Theory under Uncertainty

Firstly, a behavioral model based on the "Prospect Theory" developed by Kahneman and Tversky is described. In this model weighting function of non-additive probabilities are introduced where probability of each event occurring is known. The effective application of this approach to the public sector is shown in modeling risks of extreme events with low probability and high outcome. Next, a behavioral model based on our "Prospect Theory under Uncertainty" is described where basic probability of a set of events is known but occurrence probability of each event is not known. It is shown that this model could properly explain the Ellsberg paradox of ambiguity aversion. Potential applicability of this approach to assessing global environmental-economic policies is described.