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Forward-looking experimentation of correlated alternatives

Author

Listed:
  • Wong, Yu Fu

    (Department of Economics, University of Pittsburgh)

Abstract

This paper studies how a forward-looking decision maker experiments on unknown alternatives of correlated utilities. The utilities are modeled by a Brownian motion such that similar alternatives yield similar utilities. Experimentation trades off between the continuation value of exploration and the opportunity cost of exploitation. The optimal strategy is to continuously explore unknown alternatives, and then exploit the best known alternative when the one being explored is found to be sufficiently worse than the best one. The decision maker explores unknown alternatives more quickly as they prove to be worse than the best known one. Applied to firm experimentation, my model predicts a conditional version of Gibrat's law and a linear relation between firm size and profitability.

Suggested Citation

  • Wong, Yu Fu, 2025. "Forward-looking experimentation of correlated alternatives," Theoretical Economics, Econometric Society, vol. 20(3), July.
    • Handle: RePEc:the:publsh:4960
    as

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    References listed on IDEAS

    as
    1. Conze, Antoine & Viswanathan, 1991. "Path Dependent Options: The Case of Lookback Options," Journal of Finance, American Finance Association, vol. 46(5), pages 1893-1907, December.
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    Cited by:

    1. Martino Banchio & Suraj Malladi, 2025. "Rediscovery," Papers 2504.19761, arXiv.org.

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    Keywords

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    JEL classification:

    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • D30 - Microeconomics - - Distribution - - - General
    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory

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