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Iterative Reasoning in an Experimental "Lemons" Market

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Author Info
Annette Kirstein
Roland Kirstein () (Faculty of Economics and Management, Otto-von-Guericke University Magdeburg)

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Abstract

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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File URL: http://www.ww.uni-magdeburg.de/fwwdeka/femm/a2007_Dateien/2007_14.pdf
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Publisher Info
Paper provided by Otto-von-Guericke University Magdeburg, Faculty of Economics and Management in its series FEMM Working Papers with number 07014.

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Length: 37 pages
Date of creation: Apr 2007
Date of revision:
Handle: RePEc:mag:wpaper:07014

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Related research
Keywords: 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

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References listed on IDEAS
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  1. Erik Eyster & Matthew Rabin, 2005. "Cursed Equilibrium," Econometrica, Econometric Society, vol. 73(5), pages 1623-1672, 09. [Downloadable!] (restricted)
  2. Costa-Gomes, Miguel & Crawford, Vincent P & Broseta, Bruno, 2001. "Cognition and Behavior in Normal-Form Games: An Experimental Study," Econometrica, Econometric Society, vol. 69(5), pages 1193-1235, September.
    Other versions:
  3. Nagel, Rosemarie, 1995. "Unraveling in Guessing Games: An Experimental Study," American Economic Review, American Economic Association, vol. 85(5), pages 1313-26, December. [Downloadable!] (restricted)
  4. Schotter Andrew & Weigelt Keith & Wilson Charles, 1994. "A Laboratory Investigation of Multiperson Rationality and Presentation Effects," Games and Economic Behavior, Elsevier, vol. 6(3), pages 445-468, May. [Downloadable!] (restricted)
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  5. Rosemarie Nagel & Antoni Bosch-Domènech & Albert Satorra & José García Montalvo, 1999. "One, Two, (Three), Infinity: Newspaper and Lab Beauty-Contest Experiments," Economics Working Papers 438, Department of Economics and Business, Universitat Pompeu Fabra. [Downloadable!]
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  6. Colin F. Camerer & Teck-Hua Ho & Juin-Kuan Chong, 2004. "A Cognitive Hierarchy Model of Games," The Quarterly Journal of Economics, MIT Press, vol. 119(3), pages 861-898, August. [Downloadable!] (restricted)
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