Experimenting with the Transition Rule in Dynamic Games

In dynamic environments where the strategic setting evolves across time the specific rule governing the transitions can substantially alter the incentives that agents face. This is particularly true when history-dependent strategies are used. In a laboratory study we examine whether subjects respond to the transition rule and internalize its effects on continuation values. Our main comparison is between an endogenous transition, where future states directly depend on current choices, and exogenous transitions, where the future environment is random and independent of current choices. Our evidence shows that subjects readily internalize the effect of the dynamic game transition rule on their incentives, in line with theoretical predictions.