Tolerance Of Ambiguity And Entrepreneurial Innovation

The paper builds a general equilibrium model of occupation choice, where the risks inherent in a technology embodying a new innovation are only vaguely known (ambiguous), whereas the old technology has known risks. Using the Arrow-Hurwicz criterion to characterise decision-making in the face of ambiguity, the authors distinguish agents according to their degree of ambiguity aversion. Equilibrium requires that all agents choose optimal occupations, labour markets clear, and labour contracts within firms are Pareto efficient. The paper shows that Pareto efficient contracting implies the more ambiguity tolerant individuals will assume all risk.