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The exchange paradox: Probabilistic and cognitive analysis of a psychological conundrum

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.