This paper presents a decision theory which allows subjects to account for the uncertainties of their probability estimates. This is accomplished by modelling beliefs about states of nature by means of a class of probability measures. In order to represent uncertainties of those beliefs a measure of epistemic reliability is introduced. The suggested decision theory is evaluated in the light of empirical evidence on ambiguity and uncertainty in decision making. The theory is also compared to Tversky & Kahneman's prospect theory.

In the exchange paradox, two players receive envelopes containing different amounts of money. The assignment of the amounts ensures each player has the same probability of receiving each possible amount. Nonetheless, for each specific amount a player may find in his envelope, there is a positive expectation of gain if the player swaps envelopes with the other player, in apparent contradiction with the symmetry of the game. I consider a variant form of the paradox that avoids problems with improper probabilities (...) and I argue that in it these expectations give no grounds for a decision to swap since that decision must be based on a summation of all the expectations. But this sum yields a non‐convergent series that has no meaningful value. The conflicting recommendations – that it is to one or the other player's advantage to swap – arise from different ways of grouping terms in the sum that yield an illusion of convergence. I describe a generalized exchange paradox, explore some of its properties and display another example. (shrink)

The “exchange paradox”—also referred to in the literature by a variety of other names, notably the “two-envelopes problem”—is notoriously difficult, and experts are not all agreed as to its resolution. Some of the various expressions of the problem are open to more than one interpretation; some are stated in such a way that assumptions are required in order to fill in missing information that is essential to any resolution. In three experiments several versions of the problem were used, in each (...) of which the information given was sufficient to determine an optimal choice strategy when it exists or to justify indifference regarding keeping or trading when such a strategy does not exist. College students who were presented with the various versions of the problem tended to base their choices on simple heuristics and to give little evidence of understanding the probabilistic implications of the differences in the problem statements. (shrink)

The term “exchange paradox” refers to a situation in which it appears to be advantageous for each of two holders of an envelope containing some amount of money to always exchange his or her envelope for that of the other individual, which they know contains either half or twice their own amount. We review several versions of the problem and show that resolving the paradox depends on the specifics of the situation, which must be disambiguated, and on the player's beliefs. (...) The latter psychological variables are part and parcel of the resolution. Assuming reasonable subjective distributions, exchanging cannot always be advantageous for both players. We suggest several deep-rooted psychological reasons for the considerable difficulty people demonstrably have in dealing with this problem. Implicit widespread and compelling assumptions—that affect judgement in diverse contexts—obstruct the solution. Analysing this paradox underscores the close connection between psychology and probability theory. (shrink)