Unveiling the Failure of Positive Selection

In dynamic screening problems between an uninformed seller and a privately-informed buyer, theory suggests that the presence of the buyer’s outside option leads to a significant surplus for the seller. However, this prediction relies on multiple layers of positive selection reasoning. To examine whether participants demonstrate positive selection in their belief updates, we conduct a two-round bargaining experiment with finite price alternatives, which enable us to identify first-, second-, and third-order positive selection reasoning. Few subjects adhere to the equilibrium reasoning, and the majority fail even at the first-order reasoning. Consequently, the seller payoffs fall short of the theoretical benchmark.