The ambiguity effect is a cognitive bias where decision-making is affected due to a lack of information, or an “ambiguity.” Cognitive bias is distortion in the way we perceive reality (see also cognitive distortion). ...

For example, picture an urn with 90 balls inside of it. The balls are colored red, black and yellow. 30 of the balls are red, and the other 60 are some combination of black and yellow balls, with all combinations being equally likely. In option X, drawing a red ball would earn you the $100, and in option Y, drawing a black ball would earn you the $100. The difference between the two options is that the number of red balls is certain for option X, but the number of black balls for option Y is uncertain.

Which option gives you the best chance at picking out a winning ball? The truth is that the probability of picking a winning ball is identical for both options X and Y. In option X, where the number of red balls is certain, the probability of selecting a winning ball is 1/3 (30 red balls out of 90 total balls). In option Y, despite the fact that the number of black balls is not certain, the probability of selecting a winning ball is also 1/3. This is because the range of possibilities as to the number of black balls is some amount between 0 and 60. This means that the probability of there being more than 30 black balls is the same as there being less than 30 black balls. Because of this, according to what is known as the expected-utility theory, one should be indifferent between the two options. As a result, the chances of winning the $100 are the same for both urns.

People are much more likely to want to select a ball under option X, where the probability of selecting a winning ball is, in their minds, more certain. The question as to the number of black balls under scenario Y turns people off to that option. Despite the fact that there could possibly be double the black balls to red balls, people tend to not want to take the opposing risk that there may be less than 30 black balls. The “ambiguity” behind option Y makes people want to select option X, even when they are theoretically equivalent.

This bias was discovered by Daniel Ellsberg in 1961. Ellsberg deemed these situations where the “probability is unknown” as “ambiguous,” hence the “ambiguity effect.” Daniel Ellsberg ©1990 Jock McDonald Daniel Ellsberg (born April 7, 1931) is a Jewish American former military analyst who precipitated a national uproar in 1971 when he released the Pentagon Papers, the US militarys account of activities during the Vietnam War, to The New York Times. ... 1961 (MCMLXI) was a common year starting on Sunday (the link is to a full 1961 calendar). ...

References

• Baron, J. (2000). Thinking and deciding (3d ed.). New York: Cambridge University Press.

• Ellsberg, D. (1961). Risk, ambiguity, and the Savage axioms. Quarterly Journal of Economics, 75, 643–699.