In this paper we experimentally test a theory of boundedly rational behavior in a "lemons" market. We analyze two different market designs, for which perfect rationality implies complete and partial market collapse, respectively. Our empirical observations deviate substantially from the predictions of rational choice theory: Even after 20 repetitions, the actual outcome is closer to efficiency than expected. We examine to which extent the theory of iterated reasoning contributes to the explanation of these observations. Perfectly rational behavior requires a player to perform an infinite number of iterative reasoning steps. Boundedly rational players, however, carry out only a limited number of such iterations. We have determined the iteration type of the players independently from their market behavior. A significant correlation exists between the iteration types and the observed price offers.
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Paper provided by Otto-von-Guericke University Magdeburg, Faculty of Economics and Management in its series FEMM Working Papers with number
07014.
Find related papers by JEL classification: D8 - Microeconomics - - Information, Knowledge, and Uncertainty C7 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory B4 - Schools of Economic Thought and Methodology - - Economic Methodology
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References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
Erik Eyster & Matthew Rabin, 2005.
"Cursed Equilibrium,"
Econometrica,
Econometric Society, vol. 73(5), pages 1623-1672, 09.
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