Working papers results

Psychological game theory (PGT), introduced by Geanakoplos, Pearce & Stacchetti (1989) and significantly generalized by Battigalli & Dufwenberg (2009), extends the standard game theoretic framework by letting players'utility at endnodes depend on their interactive beliefs. While it is understood that a host of applications that model and/or test the role of emotional and other psychological forces find their home in PGT, the framework is abstract and comprises complex mathematical objects, such as players' infinite hierarchies of beliefs. Thus, PGT provides little guidance on how to model specific belief-dependent motivations and use them in game theoretic analysis. This paper takes steps to fill this gap. Some aspects are simplified -e.g., which beliefs matter -but others are refined and brought closer to applications by providing more structure. We start with belief-dependent motivations and show how to embed them in game forms to obtain psychological games. We emphasize the role of time and of the perception of players' intentions. We take advantage of progress made on the foundations of game theory to expand and improve on PGT solution concepts.

We consider multi-stage games with incomplete information and observable actions, and we analyze strategic reasoning by means of epistemic events within a total state space made of all the profiles of behaviors (paths of play) and possibly incoherent infinite hierarchies of conditional beliefs. Thus, we do not rely on types structures, or similar epistemic models. Subjective rationality is defined by the conjunction of coherence of belief hierarchies, rational planning, and consistency between plan and on-path behavior. Since consistent hierarchies uniquely induce beliefs about behavior and belief hierarchies of others, we can define rationality and common strong belief in rationality, and analyze their behavioral and low-order beliefs implications, which are characterized by strong rationalizability. Our approach allows to extend known techniques to the epistemic analysis of psychological games where the utilities of outcomes depend on beliefs of order k or lower. This covers almost all applications of psychological game theory.

This paper shows that vertical foreclosure can have a dynamic rationale. By refusing to supply an efficient downstream rival, a vertically integrated incumbent sacrifices current profits but can exclude the rival by depriving it of the critical profits it needs to be successful. In turn, monopolising the downstream market may prevent the incumbent from losing most of its future profits because: (a) it allows the incumbent to extract more rents from an efficient upstream rival if future upstream entry cannot be discouraged; or (b) it also deters future upstream entry by weakening competition for the input and reducing the post-entry profits of the prospective upstream competitor.

We use monthly data on the US riskless yield curve for a 1982-2015 sample to show that mixing simple regime switching dynamics with Nelson-Siegel factor forecasts from time series models extended to encompass variables that summarize the state of monetary policy, leads to superior predictive accuracy. Such spread in forecasting power turns out to be statistically significant even controlling for parameter uncertainty and sample variation. Exploiting regimes, we obtain evidence that the increase in predictive accuracy is stronger during the Great Financial Crisis in 2007-2009, when monetary policy underwent a significant, sudden shift. Although more caution applies when transaction costs are accounted for, we also report that the increase in predictive power owed to the combination of regimes and of monetary variables that capture the stance of unconventional monetary policies is tradeable. We devise and test butterfly strategies that trade on the basis of the forecasts from the models and obtain evidence of riskadjusted profits both per se and in comparisons to simpler models.

Consider a set of agents who play a network game repeatedly. Agents may not know the network. They may even be unaware that they are interacting with other agents in a network. Possibly, they just understand that their optimal action depends on an unknown state that is, actually, an aggregate of the actions of their neighbors. Each time, every agent chooses an action that maximizes her instantaneous subjective expected payoff and then updates her beliefs according to what she observes. In particular, we assume that each agent only observes her realized payoff. A steady state of the resulting dynamic is a selfconfirming equilibrium given the assumed feedback. We characterize the structure of the set of selfconfirming equilibria in the given class of network games, we relate selfconfirming and Nash equilibria, and we analyze simple conjectural best-reply paths whose limit points are selfconfirming equilibria.

We present a theory of identity politics that builds on two ideas. First, voters identify with the social group whose interests are closest to theirs and that features the strongest policy conflict with outgroups. Second, identification causes voters to slant their beliefs toward the group's distinctive opinion. The theory yields two main implications: i) voters' beliefs are polarized and distorted along group boundaries; ii) economic shocks that induce new cleavages to emerge also bring about large changes in beliefs and preferences across many policy issues. In particular, exposure to globalization or cultural changes may induce voters to switch identities, dampening their demand for redistribution and exacerbating conflicts in other social dimensions. We show that survey evidence is consistent with these implications.

I study unawareness by the lack of knowledge on a generalized state space. In order to understand and contrast properties of unawareness in a non-partitional standard state space model and a partitional generalized state space model, I provide a generalized framework that accommodates both models. I ask: when and how a generalized (in particular, standard) state space model has a sensible form of unawareness; and how unawareness relates to ignorance and possibility. First, unawareness can only take two forms: an agent is ignorant of knowing that she does not know an event; and the agent is ignorant of knowing an event. In either case, unawareness is also associated with the ignorance of the possibility of knowing an event. Second, the agent, who is unaware of an event, is ignorant (but not necessarily unaware) of being unaware of it. Third, the agent, facing infinitely many objects of knowledge, may know that there is an event of which she is unaware, while she cannot know that she is unaware of any particular event. Fourth, getting more information can cause the agent to become unaware of some event.

Journal of Economic Literature Classification Numbers: C70, D83

We exploit one of the largest data leaks to date to study whether and how firms use secret offshore vehicles. From the leaked data, we identify 338 listed firms as users of secret offshore vehicles and document that these vehicles are used to finance corruption, avoid taxes, and expropriate shareholders. Overall, the leak erased $174 billion in market capitalization among implicated firms. Following the increased transparency brought about by the leak, implicated firms experience lower sales from perceptively corrupt countries and avoid less tax. We estimate conservatively that one in seven firms have offshore secrets.

This paper formalizes an informal idea that an agent's knowledge is characterized by a collection of sets such as a -algebra within the framework of a state space model of knowledge. The formalization is based on the agent's logical and introspective abilities and on the underlying structure of the state space. The agent is logical and introspective about what she knows if and only if her knowledge is summarized by a collection of events with the property that, for any event, the collection has the maximal event included in the original event. When the underlying space is a measurable space, the collection becomes a -algebra if and only if the agent is additionally introspective about what she does not know. The paper characterizes why the agent's knowledge takes (or does not take) such a set algebra as a -algebra or a topology, depending on the agent's logical and introspective abilities and on the underlying environment.

Journal of Economic Literature Classification Numbers: C70, D83

We consider revealed preference relations over risky (or uncertain) prospects, and allow them to be nontransitive and/or fail the classical Independence Axiom. We identify the rational part of any such preference relation as its largest transitive subrelation that satisfies the Independence Axiom and that exhibits some coherence with the original relation. It is shown that this subrelation, which we call the rational core of the given revealed preference, exists in general, and under fairly mild conditions, it is continuous. We obtain various representation theorems for the rational core, and decompose it into other core concepts for preferences. These theoretical results are applied to compute the rational cores of a number of well-known preference models (such as Fishburn's SSB model, justifiable preferences, and variational and multiplier modes of rationalizable preferences). As for applications, we use the rational core operator to develop a theory of risk aversion for nontransitive nonexpected utility mod als (which may not even be complete). Finally, we show that, under a basic monotonicity hypothesis, the Preference Reversal Phenomenon cannot arise from the rational core of one's preferences.