*EPICENTER *Working Paper Series

**2017:**

Niels Mourmans: Reasoning about the surprise exam paradox: An application of psychological game theory, *EPICENTER *Working Paper No. 12 (2017)

*Abstract:*

In many real-life scenarios, decision-makers do not exclusively care for materialized outcomes from decisions they and their co-players make but also display other-regarding preferences such as reciprocity and surprise. Psychological game theory is able to model such belief-dependent motivations. In this paper we discuss the reasoning concepts of common belief in rationality and common belief in future rationality in a psychological game-theoretic setting and use them to provide an explanation for the puzzle of the Surprise Exam Paradox. We consider two versions of the surprise exam game, both in a static and dynamic scenario. In the version that best captures the actual crux of the paradox, we show that, as long as no cautious reasoning is imposed, full surprise is always possible. This contrasts the previous game-theoretic literature on the Surprise Exam Paradox, which relied on equilibrium concepts for traditional and psychological games alike and showed that at most partial surprise is possible under these concepts.

Christian Bach and Andrés Perea: Generalized Nash Equilibrium without Common Belief in Rationality, *EPICENTER *Working Paper No. 11 (2017)

*Abstract: *

This note considers generalized Nash equilibrium as an incomplete information analogue of Nash equilibrium and provides an epistemic characterization of it. It is shown that the epistemic conditions do not imply common belief in rationality. For the special case of complete information, an epistemic characterization of Nash equilibrium ensues as a corollary.

Stephan Jagau and Andrés Perea: Common belief in rationality in psychological games,* **EPICENTER* Working Paper No. 10 (2017)

*Abstract: *

Belief-dependent motivations and emotional mechanisms such as surprise, anxiety, anger, guilt, and intention-based reciprocity pervade real-life human interaction. At the same time, traditional game theory has experienced huge difficulties trying to capture them adequately. Psychological game theory, initially introduced by Geanakoplos et al. (1989), has proven to be a useful modeling framework for these and many more psychological phenomena. In this paper, we use the epistemic approach to psychological games to systematically study common belief in rationality, also known as correlated rationalizability. We show that common belief in rationality is possible in any game that preserves rationality at infinity, a mild requirement that is considerably weaker than the previously known continuity conditions from Geanakoplos et al. (1989) and Battigalli and Dufwenberg (2009). Also, we provide an example showing that common belief in rationality might be impossible in games where rationality is not preserved at infinity. We then develop an iterative procedure that, for a given psychological game, determines all rationalizable choices. In addition, we explore classes of psychological games that allow for a simplified procedure.

Christian Bach and Andrés Perea: Incomplete Information and Equilibrium, *EPICENTER *Working Paper No. 9 (2017)

*Abstract:*

In games with incomplete information Bayesian equilibrium constitutes the prevailing solution concept. We show that Bayesian equilibrium generalizes correlated equilibrium from complete to incomplete information. In particular, we provide an epistemic characterization of Bayesian equilibrium as well as of correlated equilibrium in terms of common belief in rationality and a common prior. Bayesian equilibrium is thus not the incomplete information counterpart of Nash equilibrium. To fill the resulting gap, we introduce the solution concept of generalized Nash equilibrium as the incomplete information analogue to Nash equilibrium, and show that it is more restrictive than Bayesian equilibrium. Besides, we propose a simplified tool to compute Bayesian equilibria.

Andrés Perea: Order Independence in Dynamic Games, *EPICENTER *Working Paper No. 8 (2017)

*Abstract:*

In this paper we investigate the order independence of iterated reduction procedures in dynamic games. We distinguish between two types of order independence: with respect to strategies and with respect to outcomes. The first states that the specific order of elimination chosen should not affect the final set of strategy combinations, whereas the second states that it should not affect the final set of reachable outcomes in the game. We provide sufficient conditions for both types of order independence: monotonicity, and monotonicity on reachable histories, respectively.

We use these sufficient conditions to explore the order independence properties of various reduction procedures in dynamic games: the extensive-form rationalizability procedure (Pearce (1984), Battigalli (1997)), the backward dominance procedure (Perea (2014)) and Battigalli and Siniscalchi’s (1999) procedure for jointly rational belief systems (Reny (1993)). We finally exploit these results to prove that every outcome that is reachable under the extensive-form rationalizability procedure is also reachable under the backward dominance procedure.

**2016:**

Christian Bach and Andrés Perea: Incomplete Information and Generalized Iterated Strict Dominance, *EPICENTER *Working Paper No. 7 (2016)

*Abstract: *

In games with incomplete information, players face uncertainty about the opponents’ utility functions. We follow Harsanyi’s (1967-68) one-person perspective approach to modelling incomplete information. Moreover, our formal framework is kept as basic and parsimonious as possible, to render the theory of incomplete information accessible to a broad spectrum of potential applications. In particular, we formalize common belief in rationality and provide an algorithmic characterization of it in terms of decision problems, which gives rise to the non-equilibrium solution concept of generalized iterated strict dominance.

**2015:**

Christian Nauerz and Andrés Perea: Local Prior Expected Utility: a basis for utility representations under uncertainty, *EPICENTER* Working Paper No. 6 (2015)

*Abstract:* Abstract Models of decision-making under ambiguity are widely used in economics. One stream of such models results from weakening the independence axiom in Anscombe et al. (1963). We identify necessary assumptions on independence to represent the decision maker’s preferences such that he acts as if he maximizes expected utility with respect to a possibly local prior. We call the resulting representation Local Prior Expected Utility, and show that the prior used to evaluate a certain act can be obtained by computing the gradient of some appropriately defined utility mapping. The numbers in the gradient, moreover, can naturally be interpreted as the subjective likelihoods the decision maker assigns to the various states. Building on this result we provide a unified approach to the representation results of Maximin Expected Utility and Choquet Expected Utility and characterize the respective sets of priors.

Andrés Perea: Forward Induction Reasoning versus Equilibrium Reasoning *EPICENTER *Working Paper No. 5 (2015)

*Abstract: *In the literature on static and dynamic games, most rationalizability concepts have an *equilibrium counterpart*. In two-player games, the equilibrium counterpart is obtained by taking the associated rationalizability concept and adding the following *correct beliefs assumption*: (a) a player believes that the opponent is correct about his beliefs, and (b) a player believes that the opponent believes that he is correct about the opponent’s beliefs. This paper shows that there is no equilibrium counterpart to the forward induction concept of *extensive-form rationalizability* (Pearce (1984), Battigalli (1997)), epistemically characterized by* common strong belief in rationality* (Battigalli and Siniscalchi (2002)). The reason is that there are games where the epistemic conditions of common strong belief in rationality are logically inconsistent with the correct beliefs assumption. In fact, we show that this inconsistency holds for “most” dynamic games of interest.

Andrés Perea and Elias Tsakas: Local Reasoning in Dynamic Games *EPICENTER *Working Paper No.4 (2015)

*Abstract:* In this paper we introduce a novel framework for modeling the players’ reasoning in a dynamic game: at each history each active player reasons about her opponents’ rationality* at certain histories only*. As a result we obtain a generalized solution concept, called *local common strong belief in rationality*, and we characterize the strategy profiles that can be rationally played under our concept by means of a simple elimination procedure. Finally, we show that standard models of reasoning can be embedded as special cases on our framework. In particular, the forward induction concept of *common strong belief in rationality* (Battigalli and Siniscalchi, 2002) is a special case of our model with the players reasoning about all histories, whereas the backward induction concept of *common belief in future rationality* (Perea, 2014) is a special case of our model with the players reasoning about future histories only.

**2014:**

Andrés Perea and Arkadi Predtetchinski: An Epistemic Approach to Stochastic Games *EPICENTER *Working Paper No.3 (2014)

*Abstract: *In this paper we focus on stochastic games with finitely many states and actions. For this setting we study the epistemic concept of common belief in future rationality, which is based on the condition that players always believe that their opponents will choose rationally in the future. We distinguish two different versions of the concept — one for the discounted case with a fixed discount factor δ, and one for the case of uniform optimality, where optimality is required for “all discount factors close enough to 1″. We show that both versions of common belief in future rationality always yield non-empty predictions for every stochastic game. This is in sharp contrast with the non-existence of subgame perfect equilibrium in many stochastic games under the uniform optimality criterion. We also provide an epistemic characterization of subgame perfect equilibrium for 2-player stochastic games, showing that it is essentially equivalent to common belief in future rationality together with some “correct beliefs assumption”. We finally present a recursive procedure to compute the set of stationary strategies that can be chosen by certain simple types under common belief in future rationality.

Christian Nauerz: Understanding reasoning in games using utility proportional beliefs *EPICENTER *Working Paper No.2 (2014)

*Abstract: *Traditionally very little attention has been paid to the reasoning process that underlies a game theoretic solution concept. When modeling bounded rationality in one-shot games, however, the reasoning process can be a great source of insight. The reasoning process itself can provide testable assertions, which provide more insight than the fit to experimental data. Based on Bach and Perea’s (2014) concept of utility proportional beliefs, I analyze the players’ reasoning process and find three testable implications: (1) Players form an initial belief that is the basis for further reasoning. (2) Players reason by alternatingly considering their own and their opponent’s incentives. (3) Players perform only several rounds of deliberate reasoning.

Andrés Perea: When Do Types Induce the Same Belief Hierarchy? *EPICENTER *Working Paper No.1 (2014)

*Abstract: *Harsanyi (1967–1968) showed how infinite belief hierarchies can be encoded by means of type structures. Such encodings, however, are far from unique: Two different types — possibly from two different type structures — may generate exactly the same belief hierarchy. In this paper we present a finite recursive procedure, the *Type Partitioning Procedure*, which verifies whether two types, from two potentially different finite type structures, induce the same belief hierarchy or not. Important is that the procedure does not make explicit reference to belief hierarchies, but operates entirely within the “language” of type structures. In the second part of this paper we relate the procedure to the notion of type morphisms and hierarchy morphisms between type structures.