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Endogenous depth of reasoning

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  • Larbi Alaoui

    ()

  • Antonio Penta

Abstract

We introduce a model of strategic thinking in games of initial response. Unlike standard models of strategic thinking, in this framework the player's "depth of reasoning" is endogenously determined, and it can be disentangled from his beliefs over his opponent's cognitive bound. In our approach, individuals act as if they follow a cost-benefit analysis. The depth of reasoning is a function of the player's cognitive abilities and his payoffs. The costs are exogenous and represent the game theoretical sophistication of the player; the benefit instead is related to the game payoffs. Behavior is in turn determined by the individual's depth of reasoning and his beliefs about the reasoning process of the opponent. Thus, in our framework, payoffs not only affect individual choices in the traditional sense, but they also shape the cognitive process itself. Our model delivers testable implications on players' chosen actions as incentives and opponents change. We then test the model's predictions with an experiment. We administer different treatments that vary beliefs over payoffs and opponents, as well as beliefs over opponents' beliefs. The results of this experiment, which are not accounted for by current models of reasoning in games, strongly support our theory. We also show that the predictions of our model are highly consistent quantitatively with well-known unresolved empirical puzzles. Our approach therefore serves as a novel, unifying framework of strategic thinking that allows for predictions across games.

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Bibliographic Info

Paper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 1332.

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Date of creation: Jul 2012
Date of revision: Mar 2014
Handle: RePEc:upf:upfgen:1332

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Web page: http://www.econ.upf.edu/

Related research

Keywords: cognitive cost ; depth of reasoning; higher order beliefs; level-k reasoning; strategic thinking;

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References

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  1. Stahl, Dale II & Wilson, Paul W., 1994. "Experimental evidence on players' models of other players," Journal of Economic Behavior & Organization, Elsevier, vol. 25(3), pages 309-327, December.
  2. Tomasz Strzalecki, 1969. "Depth of Reasoning and Higher Order Beliefs," Working Paper 8334, Harvard University OpenScholar.
  3. C. Monica Capra, 1999. "Anomalous Behavior in a Traveler's Dilemma?," American Economic Review, American Economic Association, vol. 89(3), pages 678-690, June.
  4. Vincent P. Crawford & Miguel A. Costa-Gomes & Nagore Iriberri, 2010. "Strategic Thinking," Levine's Working Paper Archive 661465000000001148, David K. Levine.
  5. Grosskopf, Brit & Nagel, Rosemarie, 2008. "The two-person beauty contest," Games and Economic Behavior, Elsevier, vol. 62(1), pages 93-99, January.
  6. Willemien Kets, 2012. "Bounded Reasoning and Higher-Order Uncertainty," Discussion Papers 1547, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
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Cited by:
  1. Allred, Sarah & Duffy, Sean & Smith, John, 2013. "Cognitive Load and Strategic Sophistication," MPRA Paper 47997, University Library of Munich, Germany.
  2. Lawrence C.Y Choo & Todd R. Kaplan, 2014. "Explaining Behavior in the "11-20” Game," Discussion Papers 1401, Exeter University, Department of Economics.
  3. María Cubel & Santiago Sanchez-Pages, 2014. "Gender differences and stereotypes in the beauty contest," Working Papers 2014/13, Institut d'Economia de Barcelona (IEB).

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