Finance Papers

Document Type

Journal Article

Date of this Version

2-2013

Publication Source

Management Science

Volume

59

Issue

2

Start Page

452

Last Page

469

DOI

10.1287/mnsc.1120.1645

Abstract

Backward induction is a widely accepted principle for predicting behavior in sequential games. In the classic example of the “centipede game,” however, players frequently violate this principle. An alternative is a “dynamic level-k” model, where players choose a rule from a rule hierarchy. The rule hierarchy is iteratively defined such that the level-k rule is a best response to the level-(k-1) rule, and the level-∞ rule corresponds to backward induction. Players choose rules based on their best guesses of others' rules and use historical plays to improve their guesses. The model captures two systematic violations of backward induction in centipede games, limited induction and repetition unraveling. Because the dynamic level-k model always converges to backward induction over repetition, the former can be considered to be a tracing procedure for the latter. We also examine the generalizability of the dynamic level-k model by applying it to explain systematic violations of backward induction in sequential bargaining games. We show that the same model is capable of capturing these violations in two separate bargaining experiments.

Copyright/Permission Statement

https://doi.org/10.1287/mnsc.1120.1645

Keywords

level-k models, learning, sequential games, backward induction, behavioral game theory

Embargo Date

5-9-2013

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Date Posted: 27 November 2017

This document has been peer reviewed.