Ambiguity Aversion
Read Aloud
Listen to the content using your browser's built-in voice.
Read Aloud is not supported in this browser.
Ambiguity Aversion
am-big-yoo-uh-tee uh-ver-zhun
Ambiguity aversion is the tendency to prefer known risks over unknown risks, even when the unknown option may offer better returns.
People feel uncomfortable when outcomes are unclear or information is incomplete, so they choose options where the risks and returns are easier to understand.
In investing, this often means choosing familiar and predictable options instead of newer or more complex ones—even if the latter may be more rewarding.
A salaried woman in Pune was offered two investment choices by her bank. The first was a fixed deposit offering 6.5% interest with clearly defined terms. The second was a market-linked product that claimed higher returns but did not clearly explain how those returns would be calculated or what risks were involved.
Even though she had a long-term horizon and enough savings to handle short-term ups and downs, she chose the fixed deposit. The lack of clear information about the second option made her uncomfortable, so she avoided it—even though it had the potential to perform better.
Ellsberg Paradox
behavioural finance
Definition
Ambiguity aversion is the tendency to prefer known risks over unknown risks, even when the unknown option may offer better returns.
People feel uncomfortable when outcomes are unclear or information is incomplete, so they choose options where the risks and returns are easier to understand.
In investing, this often means choosing familiar and predictable options instead of newer or more complex ones—even if the latter may be more rewarding.
Case Study
A salaried woman in Pune was offered two investment choices by her bank. The first was a fixed deposit offering 6.5% interest with clearly defined terms. The second was a market-linked product that claimed higher returns but did not clearly explain how those returns would be calculated or what risks were involved.
Even though she had a long-term horizon and enough savings to handle short-term ups and downs, she chose the fixed deposit. The lack of clear information about the second option made her uncomfortable, so she avoided it—even though it had the potential to perform better.
Historical Reference
Ellsberg Paradox
behavioural finance
Illustration
