Ambiguity Aversion and Incompleteness of Contractual Form.

Subjective uncertainty is characterized by ambiguity if the decisionmaker has an imprecise knowledge of the probabilities of payoff-relevant events. In such an instance, subjective beliefs are better represented by a set of probability functions than by a unique probability function. An ambiguity-averse decisionmaker adjusts his choice on the side of caution in response to his imprecise knowledge of the odds. This paper shows that ambiguity aversion can explain the existence of incomplete contracts. The contextual setting is the investment hold-up model which has been the focus of much of the research on incomplete contracts. Copyright 1998 by American Economic Association.