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American Economic Review: Vol. 103 No. 7 (December 2013)

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Polarization and Ambiguity

Article Citation

Baliga, Sandeep, Eran Hanany, and Peter Klibanoff. 2013. "Polarization and Ambiguity." American Economic Review, 103(7): 3071-83.

DOI: 10.1257/aer.103.7.3071

Abstract

We offer a theory of polarization as an optimal response to ambiguity. Suppose individual A's beliefs first-order stochastically dominate individual B's. They observe a common signal. They exhibit polarization if A's posterior dominates her prior and B's prior dominates her posterior. Given agreement on conditional signal likelihoods, we show that polarization is impossible under Bayesian updating or after observing extreme signals. However, we also show that polarization can arise after intermediate signals as ambiguity averse individuals implement their optimal prediction strategies. We explore when this polarization will occur and the logic underlying it.

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Authors

Baliga, Sandeep (Northwestern U)
Hanany, Eran (Tel Aviv U)
Klibanoff, Peter (Northwestern U)

JEL Classifications

D81: Criteria for Decision-Making under Risk and Uncertainty
D82: Asymmetric and Private Information; Mechanism Design
D83: Search; Learning; Information and Knowledge; Communication; Belief


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