Iterative Reasoning in an Experimental "Lemons" Market
AbstractIn 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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Bibliographic InfoPaper provided by Otto-von-Guericke University Magdeburg, Faculty of Economics and Management in its series FEMM Working Papers with number 07014.
Length: 37 pages
Date of creation: Apr 2007
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bounded rationality; market failure; adverse selection; regulatory failure; paternalistic regulation;
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
This paper has been announced in the following NEP Reports:
- NEP-ALL-2007-05-12 (All new papers)
- NEP-CBE-2007-05-12 (Cognitive & Behavioural Economics)
- NEP-EXP-2007-05-12 (Experimental Economics)
- NEP-MIC-2007-05-12 (Microeconomics)
- NEP-REG-2007-05-12 (Regulation)
- NEP-UPT-2007-05-12 (Utility Models & Prospect Theory)
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