What is Ambiguity (uncertainty) aversion?
Ambiguity aversion is the preference for known risks over unknown risks. People generally prefer a gamble with a stated 50% chance of winning over one where the odds are simply unknown, even if the unknown odds might be higher.
How it works
Daniel Ellsberg demonstrated this in 1961 with his famous urn experiment. Given a choice between drawing from an urn with a known 50/50 mix of balls versus an urn with an unknown mix, most people choose the known urn, violating expected utility theory.
Applied example
Investors often overweight domestic stocks over foreign ones not because domestic companies perform better, but because foreign markets feel less familiar and harder to predict, a pattern known as home bias.
Why it matters
Ambiguity aversion explains why people overpay for certainty and underinvest in opportunities where the probabilities are hard to estimate, even when the expected value is favorable.
