The testing principle: Inductive reasoning and the Ellsberg paradox

Thinking and Reasoning 2 (1):33 – 49 (1996)
Abstract
We postulate the Testing Principle : that individuals ''act like statisticians'' when they face uncertainty in a decision problem, ranking alternatives to the extent that available evidence allows. The Testing Principle implies that completeness of preferences, rather than the sure-thing principle , is violated in the Ellsberg Paradox. In the experiment, subjects chose between risky and uncertain acts in modified Ellsberg-type urn problems, with sample information about the uncertain urn. Our results show, consistent with the Testing Principle, that the uncertain urn is chosen more often when the sample size is larger, holding constant a measure of ambiguity (proportion of balls of unknown colour in the urn). The Testing Principle rationalises the Ellsberg Paradox. Behaviour consistent with the principle leads to a reduction in Ellsberg-type violations as the statistical quality of sample information is improved, holding ambiguity constant. The Testing Principle also provides a normative rationale for the Ellsberg paradox that is consistent with procedural rationality.
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