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Endogenous Depth of Reasoning

Author

Listed:
  • 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. Behaviour 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, both qualitatively and 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.

Suggested Citation

  • Larbi Alaoui & Antonio Penta, 2016. "Endogenous Depth of Reasoning," Review of Economic Studies, Oxford University Press, vol. 83(4), pages 1297-1333.
  • Handle: RePEc:oup:restud:v:83:y:2016:i:4:p:1297-1333.
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    File URL: http://hdl.handle.net/10.1093/restud/rdv052
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    References listed on IDEAS

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    1. Vincent P. Crawford & Miguel A. Costa-Gomes, 2006. "Cognition and Behavior in Two-Person Guessing Games: An Experimental Study," American Economic Review, American Economic Association, vol. 96(5), pages 1737-1768, December.
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    JEL classification:

    • C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games
    • C92 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Group Behavior
    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General

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