Charlie
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Charles Holt's Research
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Narrative Description of Research on Stochastic Game Theory Academic Vita (with links to *.pdf files for all publications) Data and Instructions (appendices for laboratory experiments) Y2K Bibliography (2000 listings in experimental economics) Survey Papers on Experimental Economics
(by
topic)
Relaxing the Assumptions of Perfect Rationality
Laboratory Experiments in Economics
Experimental Economics
Contents:
I. Game Theory and Laboratory Experiments: Historical Perspective Economics in the early twentieth century pertained almost exclusively to "price theory," which assumes that traders respond passively to price signals without thinking strategically about rivals' actions and reactions. This theory can be effectively applied to `thick' markets with lots of traders and good information, but John von Neumann and Oscar Morgenstern realized that many economic interactions like bilateral bargaining or bidding in auctions are not adequately modeled by price theory. Although their Theory of Games and Economic Behavior was reviewed on the front page of the New York Times and was widely heralded in the profession, John Nash, a young mathematics graduate student at Princeton, noticed a flaw. The only games that were "solved" were zerosum games, i.e. those with the special property that one person's gain exactly equals another's loss. Nash approached von Neumann, who was then Chair of the Princeton Mathematics Department, with a more general equilibrium analysis, which von Neumann dismissed as merely a mathematical "fixed point" argument. The notion of equilibrium is analogous to a state of rest in a physical system. An equilibrium in an interactive social system is, roughly speaking, a state in which people choose strategies of action, and there is no tendency for the system to change if each person does not want to change their own strategy, given what they know about the strategies chosen by the others. Nash provided a formal definition of equilibrium and proved that such an equilibrium would in fact exist in a wide class of strategic games. Nash's thesis advisor, Arnold Tucker, sent the proof to the Proceedings of the National Academy of Sciences about fifty years ago, resulting in a halfpage NobelPrize winning paper. On the other coast, a group of mathematicians and economists at the RAND Corporation heard about Nash's proof and were immediately interested, since the von Neumann/Morgenstern zerosum paradigm did not fit well with the possibility of mutual destruction from a nuclear exchange that loomed so large in the 1950's. The same day that word of Nash's proof arrived in Santa Monica, two mathematicians ran a laboratory experiment designed to determine whether behavior of financially motivated people would conform to the predicted behavior (it didn't). Tucker happened to pass by and see the payoff numbers written on the blackboard, and he used them to invent the story of the "prisoner's dilemma" for a talk on recent developments in game theory at the Stanford Psychology Department. The prisoner's dilemma is a game in which the best decision one can make (in private) does not depend on what the other person does, i.e. the prosecutor makes promises and threats to two prisoners in such a manner that each is better off confessing to a crime regardless of whether the other confesses, even though both would be better off if neither confessed. The Nash equilibrium is for both to confess, which produces an (admittedly unhappy) state of rest. The prisoner's dilemma has become a paradigm for many aspects of strategic interaction, although there are others that will be discussed below. In the meantime, game theory itself has finally assumed the central role in economics first envisioned by von Neumann and Morgenstern, although ironically, the Nash equilibrium has replaced their earlier solutions as the central element in the theory. Game theory is being increasingly applied in law, management, psychology, political science, and to some extent in systems engineering, artificial intelligence, biology, sociology and anthropology. In my opinion, game theory is the closest thing there is to a unified theory of social science. Game theory is especially
useful in situations where well developed markets and prices are not available,
e.g. for the analysis of coordination within a firm, family, tribe, or
government agency. It is also essential in contexts where people are trying
to anticipate others' decisions, as with firms in concentrated industries,
or governments considering strategic international trade issues. To a large
extent, the focus of economic analysis is on the equilibria of complex
interactions, and the requirements for formal models of strategic behavior
limit the behavior that can be accommodated. Although the Nash equilibrium
can apply to a wide range of social situations, for example, it still requires
very restrictive rationality assumptions. An alternative approach that
emerges from computer science and artificial intelligence is to write complex
computer simulations that program adaptive responses into simulated human
players. A second alternative is to rely more on nonmathematical insights
about human behavior gleaned from the social psychology literature. Our
work is influenced by these approaches; we seek to broaden the behavioral
possibilities that can be considered, while preserving the possibility
of using formal models to produce precise predictions that increase the
power and usefulness of game theory. The next section describes three closely
related perspectives of this new stochastic game theory: introspection
for games played once, learning for repeated games, and equilibrium for
longrun steady states.
II. Three Complementary Approaches Introspection and OneShot Games
For example, consider a "matching pennies" game in which a soccer player can either kick to the East side or the West side, and the goalie can either dive East or West. Suppose that a "match" (the goalie dives to meet the kick) gives payoffs of 1 to the goalie and 1 to the kicker, whereas a mismatch gives 1 to the goalie and +1 to the kicker. Each player wants to be unpredictable, and the only Nash equilibrium for this symmetric game is for each player to choose each direction with probability 1/2 (otherwise at least one player would want to change their behavior). This prediction is confirmed in laboratory matching pennies games. Now consider what happens if the fans of the goalie's team, who are seated on the East side of the field, announce publicly that they will donate ten thousand dollars to the team scholarship fund if the goalie blocks a kick on the East side. This only increases the goalie's payoff for the (diveEast, kickEast) outcome, but it cannot increase the Nash equilibrium probability that the goalie dives East, since the kicker must remain indifferent over the two kick directions in a Nash equilibrium with randomized decisions. This unintuitive prediction, that a change in a player's own payoff for one of the outcomes will not change that player's probability of choosing that outcome, is dramatically rejected in the experiments based on asymmetric matching pennies games. Thus the Nash equilibrium works well in the symmetric game and it predicts poorly in the asymmetric matching pennies game. We show that intuitive contradictions like this are explained by a simple model of "noisy introspection" (about what the other person might do, of what the other person thinks I might do, of what they think I think, etc.). It is well known that a succession of noisefree iterated best responses may not converge, or if it does, it will converge to a Nash equilibrium, which cannot explain behavior in the "contradiction" treatments. The innovation in our model is the injection of increasing amounts of noise into the iterated thought process: one is assumed to be less uncertain about the other person's decisions than about the other's beliefs about my decisions, etc. In "A Model of Noisy Introspection," (Goeree and Holt, forthcoming in Games and Economic Behavior) we show that the introspective equilibrium always exists and that it provides a good explanation of deviations from standard equilibrium predictions in a series of 37 oneshot game experiments. This model relaxes two extreme rationality assumptions of a Nash equilibrium: rational choice (no mistakes in choosing the action with the highest expected payoff) and rational expectations (belief distributions about others' actions correspond to actual distributions of decisions). This noisy introspection model is useful for the analysis of games played only once, which is a good description of many interactions in politics, war, legal disputes, and auctions. Logit Equilibrium
The effects of bounded rationality are illustrated dramatically in "Anomalous Behavior in a Traveler's Dilemma?" (Capra, Goeree, Gomez, and Holt, American Economic Review, 1999). The motivating story is that two travelers lose bags with identical value, and the airline representative asks them to fill out claims independently, with the constraint that claims must be in some prespecified range, e.g. between $80 and $200. The travelers will be reimbursed if the claims are equal, but if claims are unequal the assumption is that the high claimant overstated the value, so both are reimbursed at the minimum of the two claims. Moreover, the low claimant receives a reward of $R and the high claimant's reimbursement is reduced by a corresponding amount. For example, if the claims are 99 and 100, then the minimum claim is 99, so the first person receives 99 + R and the second earns 99  R. Each person would have an incentive to "undercut" the other's claim if it were known, and the unique Nash equilibrium (with rational choice and rational expectations) is for both to claim the lowest possible amount ($80 in the example). Notice that this argument does not depend on the size of the penalty/reward rate R. i.e. whether it is a matter or pennies or $100. The traveler's dilemma is no more about travel claims than the prisoner's dilemma is about confessions. In each case, the goal is to devise a stylized situation or paradigm that captures the key elements of the strategic landscape for a class of applications. This means preserving the essential economic structure of the game and stripping away or holding constant the rich framing and contextual elements of any particular choice problem, so that the effects of changes in economic incentives can be evaluated. As noted above, the remarkable feature of the traveler's dilemma game is that the equilibrium prediction is independent of R, the penalty reward parameter. But if R is low (e.g. pennies), there is little risk in raising the travel claim, and if R is large (e.g. $50), there is considerable risk, so intuition suggests that claims will be higher with a low penalty parameter. This intuition is confirmed in the laboratory experiments: the Nash equilibrium predicts well for high penalty parameters, but the data cluster at the opposite end of the set of feasible claims when R is low. The logit equilibrium model explains data in both cases, at least after the data settle down in a steady state. Learning and Evolution
One reaction that we sometimes encounter is that noise is transitory, just as random wave action may not have much effect on the predictable patterns of ocean tides. This reaction is understandable, since one might expect a small amount of decision error would only add "noise" around the predictions of a theory with no errors, e.g. the predicted Nash equilibrium claim of 80 in the traveler's dilemma example. In an interactive game, however, there can be synergies that make the effects of noise much more analogous to the momentum that accumulates in atmospheric weather patterns. For example, if noise causes an upward drift in one person's decisions, then this changes the landscape of others' expected payoffs, causing them to drift upward, and the resulting "herd effect" may move the data to a noisy equilibrium that is nowhere near the Nash equilibrium prediction. In the process, the boundedly rational players are not solving any equations, they are merely reacting to the positive and negative results of noisy local changes. We use an interactive version of the FokkerPlanck equation from theoretical physics to model a naive "hillclimbing" adjustment process (with Brownian motion) that is shown to have the logit equilibrium as a steady state. This work is reported in "Stochastic Game Theory: Adjustment to Equilibrium Under Noisy Directional Learning" (Anderson, Goeree, and Holt). The recent history of economic
methodology supports the Lakatosian notion that a theory will not be abandoned
unless a better alternative is available. In fact, laboratory violations
of Nash predictions have had little effect on applied game theory models
in the absence of a widely accepted alternative. If anything, game theory
has become more enshrined in its mathematical armor, with new specialty
journals, recent Nobel prizes, and an international Game Theory Society
holding its first World Congress in July 2000. The isolation of game theory
is reflected in a remark by Nobel Laurate Reinhard Selten: "Game theory
is for proving theorems, not for playing games." One problem has been that
strategic interactions occur in uncontrolled situations that are subject
to various alternative interpretations. Controlled experiments have been
relatively new in mainstream economics, and until recently experimental
economics has not been taught at the top10 U.S.graduate programs. Consequently,
game theory has undergone considerable refinement with only indirect exposure
to behavioral evidence, and indeed the adjectives that precede some theoretical
concepts sound more theological than scientific, e.g. "subgame perfectness,"
"the divinity refinement," or "purification of equilibria." Sometimes theoretical
intuition even seems to substitute for data; as Richard Thaler once quipped
at a psychology conference, "When economists say that the evidence is mixed,
they often mean that the theory says one thing and the data say something
else." The goal of the traveller's dilemma paper and the others in the
bounded rationality series is to redirect the focus to explaining intuitive
behavioral anomalies with formal models that relax the perfect rationality
assumptions. The next section describes a number of applications where
intuitive deviations from Nash predictions are explained by the incorporation
of noise into interactive models.
III. Applications of Stochastic Game Theory Rent Seeking
"...say that a franchise was going to be awarded to a company by a State government. Once the franchise is given out, the company getting it would be a monopolist. Obviously, many companies would like to be awarded such a contract and would spend resources on lawyers, lobbyists, and politicians trying to get it. When the `competition' is over, however, there is only one winner who gets the franchise and earns the `rents' available....For the losers, all of the resources they expended are lost....The conventional theory for such auctions exhibits several features. For example, in equilibrium, all rent is dissipated by the expenditures of firms trying to get the franchise.... not exactly what we observe in reality. In many cases it may be possible for firms to overdissipate the rents by collectively spending more to receive a franchise than the franchise is worth to any one of them (a clear social inefficiency)." This rent seeking process is like an "allpay auction" in which the prize goes to the highest bidder, but all have to pay their bids, since bidding in done by spending money on lobbying and franchise application procedures. A Nash equilibrium for these rentseeking games can produce underdissipation or exact dissipation of rents, but never overdissipation, since this would yield losses that could be avoided by not competing for the franchise. In contrast, overdissipation is possible in models that relax the assumption of perfect rationality, as described in "Rent Seeking with Bounded Rationality: An Analysis of the All Pay Auction" (Anderson, Goeree, and Holt, 1998, Journal of Political Economy). Even though rent is always exactly dissipated in a Nash equilibrium for the allpay auction, the logit equilibrium predicts that rent dissipation is greater when there are more competitors for the rent. This paper provides an explanation for the qualitative patterns of overdissipation observed in some laboratory experiments. Coordination
This intuition, that efforts will be higher with low effort cost, is confirmed by our laboratory experiments, and again, the logit equilibrium predictions track the data nicely. Efforts are intermediate and tend to rise in the lowcost treatment, and they start at about the same initial level and tend to fall in the highcost treatment. In each case, the effort level trajectories tend to flatten after several periods of random rematching of players, and then average levels are quite close to the predictions of the logit equilibrium ("An Experimental Study of Costly Coordination," Goeree and Holt, 1999). The stag hunt game is another of those gametheory paradigms, which in this case has been used as a proving ground for theories designed to choose among multiple Nash equilibria. Our approach predicts a unique probability distribution over decisions, and the derivation of this distribution is analogous to the minimization of potential energy in a physical system. In game theory, a potential function is a mathematical formula that is positively related to individual players' payoffs: when a change in a player's own decision raises that player's payoff, then this change necessarily raises the value of the potential function by the same amount, and vice versa for decreases. If such a potential function exists for the game, then each person trying to increase their own payoff may produce a group result that maximizes the potential function for the game as a whole. Think of two people holding adjacent sides of a treasure box, with one pulling uphill along the EastWest direction and the other pulling uphill along the NorthSouth axis. Even though each person is only pulling in one direction, the net effect will be to take the box to the top of the hill, where there is no tendency to change (a Nash equilibrium that maximizes potential). When there is some randomness in the individual directional movements, the dynamic system maximizes a "stochastic potential," which is the expected value of ordinary potential function of the game plus a measure of dispersion (entropy). We show that the maximum of stochastic potential is a logit equilibrium, which produces a unique distribution of effort levels in the coordination game. As effort costs rise, the distribution of efforts decreases, and vice versa, a result that is intuitive but not predicted by a Nash equilibrium. The intuition is that the randomness makes behavior sensitive not just to whether the incline is increasing or decreasing, but to how steep the incline actually is. This research is reported in "Minimum Effort Coordination Games: Stochastic Potential and Logit Equilibrium" (Anderson, Goeree, and Holt, Games and Economic Behavior, 2001). Binary Choice Games
IV. Incorporating a Broader Range of Human Motivation Public Goods and Altruism
Following the initial experiments of sociologists Marwell and Ames, there is a large literature on the causes of voluntary giving in controlled environments. Our experiment uses a design in which the benefits of one's own contribution to others (the "external return") is varied independently from the benefit to oneself (the "internal return"). This distinction allows a more precise estimation of the importance of altruistic concerns with others' payoffs. Some altruism is indicated by the fact that observed contributions to the public good increase as we raise the external benefit to others of one's own contribution, as reported in "Private Costs and Public Benefits: Unraveling the Effects of Altruism and Noisy Behavior" (Goeree, Holt, and Laury, Journal of Public Economics, 2002). Contributing to a public good is analogous to investing in pollution abatement that will benefit others downwind or downstream. Asymmetries in own (internal) and others' (external) benefits are evaluated in "Incentives in Public Goods Experiments: Implications for the Environment" (Goeree, Holt, and Laury, forthcoming 2003). Bargaining and Fairness
Risk Aversion in Lottery Choice, Games, and Lottery Choice
The most strident experimental controversy in the literature to date involved an exchange several years ago about risk aversion and flat payoff functions, and this paper revisits the issue by putting flatness on only one side of the payoff maximum. Consistent with economic intuition, bids are higher in the treatment with low upside risk, and lower in the treatment with high upside risk, despite the fact that the Nash equilibrium bids are the same for the two treatments. One striking feature of the logit analysis of auctions is that the predictions are so close to the aggregate bid distributions that we had to use thin lines in graphs to distinguish them. An interesting aspect of the data analysis is that there was overbidding by an amount that is rather precisely predicted by an assumption that bidders are risk averse. The effects of risk aversion show up clearly in lotterychoice settings, where the subject chooses between pairs of lotteries with different degrees of riskiness. This risk aversion is present in lowpayoff settings (prizes of several dollars), and it increases sharply when all prizes are increased by a factor of 20, and it increases again when payoffs are scaled up by a factor of 50, yielding prizes in the hundred dollar range. Moreover, risk aversion in high payoff situations is much stronger when the payoffs are "real" as opposed to being hypothetical. These results are reported in "Risk Aversion and Incentive Effects in Lottery Choices" (C. Holt and S. Laury, American Economic Review, December 2002). Many games involve situations
where the potential payoffs from playing one strategy are much less variable
than the potential payoffs from another strategy. In "Risk Averse
Behavior in Generalized Matching Pennies Games" (Goeree, Holt, and Palfrey,
forthcoming in Games and Economic Behavior), we consider a game
where all quantal response equilibria (for risk neutrality and any error
rate) are on one side of the set of choice probabilities for the two players,
but the data are clearly on the other side. We prove that risk aversion
shifts the stochastic best response functions toward higher probabilities
of using the "safe" strategy. The resulting quantal response equilibrium
with risk aversion is close to the observed data average. Maximum
likelihood estimates of the coefficient of relative risk aversion are relatively
stable across these different games.
V. A Summary of Major Scientific Insights Game theory is the closest thing to a unifying theory in social science, and it evokes some of the strongest antagonism as well. Critics argue that people are not perfectly rational, and that the experimental support for game theory is mixed. The response of some theorists is that there must be something wrong with the experiments because the theory is logically correct. The problem with this normative defense is that what is optimal in a game such as the traveler's dilemma depends on what the other players actually do, not on what some theory says they should do. Our research introduces randomness into decision making, which causes decisions to be only imperfectly related to measured economic incentives. Although the extent of this randomness is a matter of empirical estimation, the incorporation of such noise is a common element of the techniques that we use to describe the behavior of our laboratory subjects. This narrative has described three complementary modifications of classical game theory. The models of introspection, learning/evolution, and equilibrium contain the common stochastic elements that represent errors or unobserved preference shocks. These three approaches are like the "three friends" of classical Chinese gardening (pine, cherry, and bamboo), they fit together nicely, each with a different purpose. Models of iterated noisy introspection are used to explain beliefs and choices in games played only once, where surprises are to be expected, and beliefs are not likely to be consistent with choices. With repetition, beliefs and decisions can be revised via learning or evolution. Choice distributions will tend to stabilize when there are no more surprises in the aggregate, and the resulting steady state constitutes a noisy equilibrium. This general approach can usefully incorporate a broad range of human motivations, including altruism, fairness, and risk aversion, factors which improve the predictive power of equilibrium models in some of the applications we have considered. To summarize, the major scientific insights are: 1) We have developed of a new model of noisy introspection to explain anomalous behavior in games played once. This introspective solution exists and reduces to the logit quantal response equilibrium in the special case where uncertainty does not increase with successive iterations of introspective thinking. 2) We have used the logit equilibrium to explain anomalous data patterns in a range of games, especially those with a continuum of strategies, where we derive existence, uniqueness, and comparative statics proofs. The advantage of this approach is that the same formal model tracks behavior that closely conforms to Nash equilibrium predictions in one treatment and deviates sharply in another. 3) We have developed ways to incorporate broader motivations into the stochastic equilibrium models, e.g. altruism, inequity aversion, and risk aversion, with applications to public goods, bargaining, and auctions. 4) We have used learning models to explain the time patterns of directional adjustment in specific laboratory experiments. We have characterized a steadystate learning equilibrium and its relationship to the (static) logit quantal response equilibrium. 5) For potential games, we use an entropy measure of dispersion to construct a "stochastic potential function" that is maximized by a noisy evolutionary process. All maxima of this stochastic potential are logit equilibria, which generalize the popular notion of "risk dominance" for selecting among multiple equilibria in 2x2 games. These theoretical perspectives allow us to predict initial play, adjustment patterns, and final tendencies in a series of laboratory experiments. Data patterns that our colleagues would previously characterize as "behavioral" (i.e. consistent with intuition about human cognition but not with economic theory) are being picked up by these new stochastic gametheoretic models. There are discrepancies, but the overall pattern of results is surprisingly coherent, especially considering that we are using human subjects in interactive situations. The results are often precise in comparison with data from difficult physical science experiments, where impurities and extraneous forces may be hard to control. In fact, the principal investigator with a second degree in physics (Goeree) sometimes remarks that he is getting "that old physics feeling" when something unexpected happens in an economics experiment. Laboratory experiments have
been intimately connected with the development of game theory, starting
with the reaction to Nash's seminal theorem. Two of the three recipients
of the first Nobel Prize in Economics given to game theorists (Nash and
Reinhard Selten) conducted experiments, and the third (John Harsanyi) was
instrumental in the incorporation of random elements into equilibrium models.
Patterns of human data provide the landmarks that are needed to avoid becoming
lost in the jungle of possibilities once theorists move away from assumptions
of perfect rationality. The resulting models have the empirical content
that makes them relevant for playing games, not just for doing theory.
VI. Abstracts of Recent Research Papers on Stochastic Game Theory General Overview Goeree, Jacob K., and Charles A. Holt (1999) "Stochastic Game Theory: For Playing Games, Not Just for Doing Theory"Proceedings of the National Academy of Sciences, 96(September), 1056410567, http://www.pnas.org/cgi/reprint/96/19/10564. Abstract: This paper argues that noisy models of introspection, learning, and equilibrium can explain the salient behavior patterns in game experiments, patterns that are not predicted by the Nash equilibrium or its refinements. Models of iterated noisy introspection are used to explain initial choices, models of noisy learning and evolution are used to predict dynamic adjustment paths, and logit equilibrium models explain Nashinvariant treatment effects in steadystate distributions of decisions. Anderson, Simon P., Jacob K. Goeree, and Charles A. Holt (1998) "Logit Equilibrium Models of Anomalous Behavior: What to Do when the Nash Equilibrium Says One Thing and the Data Say Something Else," in Handbook of Experimental Economics Results, edited by C.R. Plott and V.L. Smith, New York: Elsevier Press, forthcoming. Abstract: This paper shows how the logit equilibrium can be used to explain anomalous data patterns in a wide variety of games such as social dilemma games, coordination games, contests, pricing games, etc. Anderson, Simon P., Jacob K. Goeree, and Charles A. Holt (1998) "Bounded
Rationality in Markets and Interactive Systems," Experimental Economics,
forthcoming. Abstract: This is a selective survey of the literature on
bounded rationality. Results from experimental economics are used to motivate
models that relax the rational choice assumptions.
Noisy Introspection Goeree, Jacob K., and Charles A. Holt (1999) "A Model of Noisy Introspection," forthcoming, Games and Economic Behavior. Abstract: The paper presents a theoretical model of noisy iterated introspection designed to explain behavior in games played only once. The equilibrium determines layers of beliefs about others' beliefs about ..., etc., but relaxes the Nashlike requirement that belief distributions coincide with distributions of decisions, i.e. it allows for systematic surprises. We prove that this thought process converges. Data from 37 oneshot matrix games are used to estimate error and introspection parameters, which allows rejection of parameter restrictions implied by Nash and logit equilibrium limit cases. Adding an introspection parameter cuts the mean squared prediction error by about half, and adding a risk aversion parameter reduces the remaining mean squared error by half. Goeree, Jacob K., and Charles A. Holt (2001) "Ten
Little Treasures of Game Theory, and Ten Intuitive Contradictions,"American
Economic Review, 91(5), 14021422. Abstract: The
"treasures" are ten static and dynamic games where behavior matches the
Nash equilibrium or relevant refinement, and the contradictions show anomalous
behavior patterns. In some games, Nash seems to only work by coincidence,
e.g. if deviation losses are symmetric or very high, and in other games
the data are repelled from the Nash prediction and pile up on the opposite
side of the set of feasible decisions.
Quantal Response Equilibrium Anderson, Simon P., Jacob K. Goeree, and Charles A. Holt (2002) "The Logit Equilibrium: A Perspective on Intuitive Behavioral Anomalies," Southern Economic Journal, 69(1) 2147.Abstract: The paper characterizes logit equilibria for a class of Nplayer games with payoffs that depend on the ranking of player's decisions, including Bertrand price competition, Hotelling's location game, the traveler's dilemma, and many variants of coordination games. General existence, symmetry, uniqueness, and comparative statics proofs are presented and applied. Anderson, Simon P., Jacob Goeree, and Charles A. Holt (1998) "Control Costs and Equilibria in Games with Bounded Rationality," Discussion Paper, presented at the Summer 1998 ESA Meetings. Abstract: Van Damme's notion of control costs is that it is more costly to implement decisions more precisely. This paper derives the relationship between control costs and noisy approaches to equilibrium in games. In twobytwo games, quantal response equilibria are equivalent to Nash equilibria with control costs. Extensions to Nplayer matrix games are discussed. Goeree, Jacob K. and Charles A. Holt (2000) "An Explanation of Anomalous Behavior in BinaryChoice Games: Entry, Voting, Public Goods, and the Volunteer's Dilemma," Discussion Paper. Abstract: This paper characterizes behavior with "noisy" decision making for a general class of Nperson, binarychoice games. Applications include: participation games, voting, market entry, binary steplevel public goods games, the volunteer's dilemma, etc. Many anomalous data patterns in laboratory experiments based on these games can be explained using the quantal response equilibrium. Goeree, Jacob K., Charles A. Holt, and Thomas Palfrey (2000)"Risk
Averse Behavior in Generalized Matching Pennies Games," forthcoming
in Games and Economic Behavior. Abstract: We consider a 2
× 2 game in which each player chooses between a relatively safe decision
and a risky decision with a large difference between the possible payoffs.
If players' utilities are correctly measured by financial rewards, the
unique Nash equilibrium and all quantal response generalizations reside
on one half of the set of choice probabilities. The observed choice
frequencies are well away on the other side. Risk aversion shifts
the stochastic best response functions toward each player's safe strategy,
and the resulting intersection of these functions is close to the observed
data.
Learning and Evolution Anderson, Simon P., Jacob K. Goeree, and Charles A. Holt (1997) "Stochastic Game Theory: Adjustment to Equilibrium Under Noisy Directional Learning," Discussion Paper. Abstract: This paper presents a dynamic model in which agents adjust their decisions in the direction of higher payoffs, subject to random error. This process produces a probability distribution of players' decisions whose evolution over time is determined by the FokkerPlanck equation. The dynamic process is stable for all potential games, a class of payoff structures that includes several widely studied games. In equilibrium, the distributions that determine expected payoffs correspond to the distributions that arise from the logit function applied to those expected payoffs. This "logit equilibrium" forms a stochastic generalization of the Nash equilibrium and provides a possible explanation of anomalous laboratory data. Capra, C. Monica, Jacob K. Goeree, Rosario Gomez, and Charles A. Holt (2002) "Learning and Noisy Equilibrium Behavior in an Experimental Study of Imperfect Price Competition," International Economic Review, 43(3), August, 613636. Abstract: The experiments implement a model of imperfect price competition in which the high price seller matches the lower price but has a lower sales quantity. The NashBertrand prediction is unaffected by the market share of the highprice seller, but the data respond sharply to changes in this parameter, a response that is consistent with dynamic and equilibrium models of noisy behavior. Simulation techniques are used to explore conditions under which the steadystate "stochastic learning equilibrium" matches the logit equilibrium, and conditions under which there are small but systematic differences due to "recency effects." Capra, C. Monica, Jacob K. Goeree, Rosario Gomez, and Charles A. Holt (1999) "Anomalous Behavior in a Traveler's Dilemma," American Economic Review, 89:3, June, 678690. Abstract: The observed choices in a traveler's dilemma experiment are moved across the entire set of feasible decisions by changes in a treatment variable that has no effect on the unique Nash prediction. Dynamic patterns are explained by a logit learning model, and the steady state distributions are centered around the predictions of a logit equilibrium that generalizes the Nash equilibrium to allow for noisy behavior. Goeree, Jacob K. and Charles A. Holt (2000) "Stochastic Learning
Equilibrium," Discussion Paper Presented at the June 2000 ESA Meeting .
Learning and adaptive behavior in an interactive context may be noisy,
due to errors in forecasting and/or decisionmaking. This paper introduces
the notion of a stochastic learning equilibrium, which is a steady
state distribution of players' histories of past decisions. We prove
existence and show that the steady states do not coincide with standard
equilibrium predictions, e.g. Nash or quantal response, except under specific
conditions. The model is general enough to include endogenous learning
rules and more mechanical reinforcement learning.
Rent Seeking Anderson, Simon P., Jacob K. Goeree, and Charles A. Holt (1998) "Rent Seeking with Bounded Rationality: An Analysis of the All Pay Auction,"Journal of Political Economy, 106:4, August, 828853. Abstract: When people expend real resources to compete for a prize, a significant part of the associated value (rent) may be dissipated in the process. A model of bounded rationality is used to explain why the extent of rent dissipation in an allpay auction may be sensitive to factors such as the number of competitors, the cost of effort, etc., which have no affect in a Nash analysis. A logit equilibrium model of boundedly rational behavior is proposed and analyzed. Goeree, Jacob K., Simon P. Anderson, and Charles A. Holt (1998) "The
War of Attrition with Noisy Players," in Advances in Applied Microeconomics,
Volume 7, edited by M.R. Baye, Greenwich, Conn.: JAI Press, 1529.
Abstract: We show that the Nash equilibria for the twoplayer normalform
war of attrition with asymmetric values involve one player choosing zero
effort (conceding immediately). Nondegenerate mixedstrategy equilibria
under different prize values are possible only when there is no maximum
effort. These equilibria have perverse comparative static properties: an
increase in one player's value leaves that player's bid distribution unaffected
and raises the other player's effort. We describe the logit equilibrium
for the game, which is symmetric when values are equal and predicts that
the player with the higher prize value exerts more effort in the asymmetric
case.
Coordination Anderson, Simon P., Jacob K. Goeree, and Charles A. Holt (2001) "MinimumEffort Coordination Games: Stochastic Potential and the Logit Equilibrium,"Games and Economic Behavior, 34(2), 177199. Abstract: This paper considers coordination games with a continuum of Paretoranked Nash equilibria. The introduction of noise error yields a unique distribution of decisions that maximizes a stochastic potential function (expected value of the potential of the game plus entropy). As the noise vanishes, the limiting distribution converges to an outcome that is analogous to the riskdominant outcome for 2×2 games. In accordance with experimental evidence and economic intuition, our results show that efforts decrease with increases in effort costs and the number of players, even though these parameters do not affect the Nash equilibria. Goeree, Jacob K., and Charles A. Holt (1999) "An
Experimental Study of Costly Coordination," Discussion Paper. Abstract:
We present and test a unified view of behavior in coordination experiments
with effortcost and numbers effects not predicted by the Nash equilibrium.
The theory is a generalization of risk dominance and maximum potential;
the maximization of stochastic potential explains (final period) effort
levels of human subjects in a series of minimum and medianeffort coordination
experiments.
Public Goods Anderson, Simon P., Jacob K. Goeree, and Charles A. Holt (1998) "A Theoretical Analysis of Altruism and Decision Error in Public Goods Games,"Journal of Public Economics, 70:2 (November), 297323. Abstract: This paper formalizes an equilibrium model in which altruism and decisionerror parameters determine the distribution of contributions in public goods games. We prove existence of a unique, symmetric equilibrium density of contributions and show that (i) contributions increase with the marginal value of the public good, (ii) total contributions increase with the number of participants if there is altruism, and (iii) mean contributions lie between the Nash prediction and half the endowment. These predictions, which are not implied by a standard Nash analysis, are roughly consistent with laboratory data. Goeree, Jacob K., Charles A. Holt, and Susan K. Laury (2002) "Private Costs and Public Benefits: Unraveling the Effects of Altruism and Noisy Behavior," Journal of Public Economics, 83(2) 257278. Abstract: The effects of a contribution to a public good are decomposed into an internal return to the contributor and an external return to each of the others. Contributions in oneshot games are generally increasing in internal returns, external returns, and group size, and a logit model of individual behavior tracks treatment averages well, both for linear and nonlinear altruism specifications. Goeree, Jacob K., Charles A. Holt, and Susan K. Laury (2000)"Incentives
in Public Goods Experiments: Implications for the Environment," forthcoming
in Frontiers of Environmental Economics, J. List and A. de Zeeuw,
eds.. Abstract: This paper reports results of an experiment
designed to evaluate the effects of externalities by altering the costs
and benefits of an investment that corresponds to pollution abatement.
In this experiment, a person can make an investment with a private (internal)
return that does not cover the investment cost, but with a public (external)
return that makes the investment socially optimal. Investments are
increasing in internal and external returns, and are virtually identical
for two treatments with the same "price," defined to be the ratio of the
external benefit to the internal loss from making an investment. Individual
forecast data make it clear that many who invest nothing are free riding
on anticipated investments by others, and most who make significant investments
in the final period do not expect others to be as generous.
Bargaining and Auctions Goeree, Jacob K., and Charles A. Holt (2000) "Asymmetric Inequality Aversion and Noisy Behavior in AlternatingOffer Bargaining Games," European Economic Review, 44, 2000, 10791089. Abstract: We report a twostage alternatingoffer bargaining experiment in which players receive asymmetric fixed money payments in addition to their earnings from the bargaining process. These endowments do not affect the perfect positive correlation between initial Nash offers and the remaining pie, but are selected to induce a perfectly negative relationship between the remaining pie size and the firststage offer that would equalize final earnings of the two players. This negative relationship is apparent in the data, which suggests the importance of fairness considerations. A model of asymmetric inequality aversion and stochastic choice is used to provide estimates of utility and logit error parameters. Goeree, Jacob K., Charles A. Holt, and Thomas R. Palfrey (2002) "Quantal
Response Equilibrium and Overbidding in PrivateValue Auctions." Journal
of Economic Theory, 104(1), 247272. Abstract: This paper reports
the results of a privatevalues auction experiment in which expected costs
of deviating from the Nash equilibrium bidding function are asymmetric,
with the implication that upward deviations will be more likely in one
treatment than in the other. Overbidding is observed in both treatments,
but is higher in the treatment where the costs of overbidding are lower.
We specify and estimate a noisy (logit) model of equilibrium behavior.
Estimated noise and risk aversion parameters are consistent across treatments
and are highly significant and of reasonable magnitudes. Alternative explanations
of overbidding are also considered. The estimates of parameters from a
cumulative probability weighting function yield a formulation that is essentially
equivalent to risk aversion.
Brief Survey Papers on Topics
in Experimental Economics
Methodology
Industrial Organization:
"The Exercise of Market Power in Laboratory Experiments" "The Effects of Collusion in Laboratory Experiments" "Industrial Organization: A Survey of Laboratory Research" "Markets with Posted Prices: Recent Results from the Laboratory" Public Goods:
"Voluntary
Provision of Public Goods: Experimental Results
Games and Information:
"Information Cascade Experiments" "Game Theory: Ten Little Treasures and Ten Intuitive Contradictions" "Logit
Equilibrium Models of Anomalous Behavior: What to do when the
