Mitigating Ambiguity Aversion via Counterfactual Priors: A Resolution of Ellsberg's Paradox

Ellsberg-type preferences violate one of the principles for Bayesian rationality, namely Savageís Sure Thing Principle, and are among the main empirical results against Subjective Expected Utility theory. In this paper, we propose a novel strategy for dealing with ambiguity aversion and the resulting Ellsberg-type choices. First, we identify the presence of "asymmetric information" as the main cause of ambiguity aversion. Second, we develop a solution for Ellsberg's paradox which emerges as a direct application of counterfactual thinking, implemented to the specific choice problem described by Ellsberg. Third we analyze the psychological, methodological and logical merits of the developed counterfactual strategy, and show that its application solves the problems of "error correction" and "unconceived alternatives", two of the main complaints about Bayesian Confirmation Theory.