Forward-looking experimentation of correlated alternatives

Yu Fu Wong ()
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Yu Fu Wong: Department of Economics, University of Pittsburgh

Theoretical Economics, Forthcoming

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.

Keywords: Experimentation; Brownian motion; firm dynamics; Gibrat's law (search for similar items in EconPapers)
JEL-codes: D21 D30 D83 (search for similar items in EconPapers)
Date: 2025-01-23
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