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Endogenous Depth of Reasoning

Larbi Alaoui () and Antonio Penta ()

No 653, Working Papers from Barcelona Graduate School of Economics

Abstract: We introduce a model of strategic thinking in games of initial response. Unlike standard level-k models, in this framework the player's `depth of reasoning' is endogenously determined, and it can be disentangled from his beliefs over his opponent's cognitive bound. In our approach, individuals act as if they follow a cost-benefit analysis. The depth of reasoning is a function of the player's cognitive abilities and his payoffs. The costs are exogenous and represent the game theoretical sophistication of the player; the benefit instead is related to the game payoffs. Behavior is in turn determined by the individual's depth of reasoning and his beliefs about the reasoning process of the opponent. Thus, in our framework, payoffs not only affect individual choices in the traditional sense, but they also shape the cognitive process itself. Our model delivers testable implications on players' chosen actions as incentives and opponents change. We then test the model's predictions with an experiment. We administer different treatments that vary beliefs over payoffs and opponents, as well as beliefs over opponents' beliefs. The results of this experiment, which are not accounted for by current models of reasoning in games, strongly support our theory. Our approach therefore serves as a novel, unifying framework of strategic thinking in games.

Keywords: cognitive cost; depth of reasoning; higher order beliefs; level-k reasoning; strategic thinking (search for similar items in EconPapers)
JEL-codes: C72 C92 D80 (search for similar items in EconPapers)
Date: 2014-03
New Economics Papers: this item is included in nep-cbe, nep-evo, nep-exp, nep-gth, nep-mic and nep-neu
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Related works:
Journal Article: Endogenous Depth of Reasoning (2016) Downloads
Working Paper: Endogenous depth of reasoning (2014) Downloads
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