Justified Communication Equilibrium

Justified communication equilibrium (JCE) is an equilibrium refinement for signaling games with cheap-talk communication. A strategy profile must be a JCE to be a stable outcome of nonequilibrium learning when receivers are initially trusting and senders play many more times than receivers. In the learning model, the counterfactual “speeches” that have been informally used to motivate past refinements are messages that are actually sent. Stable profiles need not be perfect Bayesian equilibria, so JCE sometimes preserves equilibria that existing refinements eliminate. Despite this, it resembles the earlier refinements D1 and NWBR, and it coincides with them in co-monotonic signaling games. (JEL C70, D82, D83, J23, M51)

A Foundation for Efficiency Wage Contracts

In many jobs, the worker generates only subjective performance measures privately observed by the employer, and contracts must rely on employer reports about these measures. This setting is a game with private monitoring, and prior work suggests that the optimal contract may be complex and non-recursive. I introduce a novel equilibrium refinement and show that the optimal contract simplifies to an efficiency wage contract: The worker receives a wage above his outside option and reports take a pass-fail form. Each report depends only on performance since the previous report, and effort incentives are provided purely through the threat of termination. (JEL D86, J41)

THE DYNAMICS OF NORMS AND CONVENTIONS UNDER LOCAL INTERACTIONS AND IMITATION

Restricting the analysis to general 2×2 coordination games, this article shows how under certain conditions, it is highly likely that individuals coordinate on a (pay-off) efficient through risk inferior convention. This contrasts with other equilibrium refinement criteria, such as risk dominance or stochastic stability. Here it is assumed that players are situated on a toroidal regular lattice, interact only locally and, in each period, imitate the last period's most successful player in their neighborhood. If the set of observable players by an individual and the set that he interacts with are both identical and small, pay-off dominance plays the major role in defining the long-term convention. As the latter set of players increases, a risk dominant but pay-off inferior convention becomes more likely. The model also shows that the interaction of two player types in a nonsymmetric game potentially leads to nonegalitarian conventions.

Modeling the Change of Paradigm: Non-Bayesian Reactions to Unexpected News

Bayes' rule has two well-known limitations: 1) it does not model the reaction to zero-probability events; 2) a sizable empirical evidence documents systematic violations of it. We characterize axiomatically an alternative updating rule, the Hypothesis Testing model. According to it, the agent follows Bayes' rule if she receives information to which she assigned a probability above a threshold. Otherwise, she looks at a prior over priors, updates it using Bayes' rule for second-order priors, and chooses the prior to which the updated prior over priors assigns the highest likelihood. We also present an application to equilibrium refinement in game theory. (JEL D11, D81, D83)

ON EQUILIBRIUM REFINEMENT FOR DISCONTINUOUS GAMES

In moving from finite-action to infinite-action games, standard refinements of the Nash equilibrium concept cease to satisfy certain "natural" properties. For instance, perfect equilibria in compact, continuous games need not be admissible. This paper highlights additional properties of two standard refinement specifications that are not inherited by supersets of the set of finite games. The analysis reveals the following about the behavior of perfectness and strategic stability within a class of (possibly) discontinuous games: (1) Equilibria that assign positive probability to the interior of the set of strategies weakly dominated for some player can be chosen; (2) nonadmissible equilibria need not be ruled out when they are weakly dominated by admissible perfect equilibria; and (3) nonadmissible equilibria may be selected when admissible equilibria are ruled out.